Short questions in supply chain
I run a business that averages 5% net profit on sales. I am trying to decide whether or not to embark on a purchasing project that is projected to save my company $200,000. How many dollars would I have to increase sales, without increasing expenses, in order to increase profit to match this $200,000 in savings? (Put your answer in as a number without the $ sign).My cost on a product I wish to sell is $75. My target margin is 24%, what is the calculated value that I should start with when deciding on my selling price? (don’t enter the $ sign, just the dollar value to the penny). If the answer is $183.53 (which it is not) you would enter in 183.53.I am the buyer in a warehouse. I decide to take on a new category of items. I ask my boss for some advice on the new item. One thing that he tells me is, “I would put 7% on it.” My boss is telling me the gross profit _________ percent that I should add to my products cost.
Advanced Corporate Finance
Group Homework #10
Estimation of the Bond Rating, Beta and
Required Return on Debt for the Recapitalized Firm
In this assignment you will assess the effect of a proposed change in leverage by your firm on its
bond rating and required return on debt. Handout #26 should serve as a guide in your efforts to
study the effects of recapitalization on the firm’s debt, and Handout #18 for the effect on equity.
You also need the results from Group Homework #9, where you estimate the balance sheets and
income statement of the recapitalized firm. Clearly, you should clean-up any problems with your
estimates from these assignments before proceeding.
Effects of Recapitalization on the Firm’s Bond Rating and Cost of Debt
You will try to estimate the effect of the proposed change of leverage on the firm’s bond rating.
You should use the results of the regression model based on the work of Bloom, Lim and
McKinlay (BLM). This is described in Handout #26, on pages 1 – 4. You are not to estimate the
regression yourself, you will use the parameters provided in the handout.
On the Bloomberg terminal you can find the current S&P and Moody’s ratings of the firm’s debt.
You probably collected this with the data on the firm’s debt earlier from the Bloomberg Terminal.
First, use the BLM model to estimate the hypothetical rating for the bonds of the firm as currently
levered. You will need to compute (1) the logarithm of firm size (in $M), (2) the coverage ratio,
(3) the total-debt-to-asset ratio, and (4) the ROA. The hypothetical rating that you calculate using
the regression model will probably differ from the actual. You will need to know the extent of
this discrepancy to adequately judge the effect of the recapitalization on the rating and required
yield on debt.
Next, you will use the figures from Homework #9, where you estimate income statements and
(book value) balance sheets for the recapitalized firm, to calculate the ratios (described above) at
the new capital structure. These are then substituted into the BLM model to see the effect of the
recapitalization on the bond rating. 2
Then, comes the most interesting part. You should think about how much the recapitalization may
raise the firm’s cost of debt financing. For instance, if the firm’s current rating is BBB, and you
think that the recapitalization would drop their rating by three notches (to BB), what will happen
to the yield on the bonds the firm will issue and also its outstanding debt? This is clearly not an
exact science, but requires some sound judgment on your part. I would suggest that you use the
Curve Finder (CRVF) on the Bloomberg Terminal to plot the current yield for your firm’s debt
(along the yield curve) with those for bond indices of ratings that your firm might slip into
following the recapitalization. If your firm’s curve is not available on the CRVF, you will have to
collect information on the yields of appropriate bond portfolios using the CMX function on the
Bloomberg Terminal. You need to consider not only the yield that the new bonds will bear, but
also about the firm’s existing debt; in this case it is useful to know the weighted-average time-tomaturity of the firm’s outstanding bonds (many groups have already executed this computation in
Group Homework #7). The CMX function on the Bloomberg Terminal may provide with data
that will be helpful to make such guesses.
For the analysis of the effect of the recapitalization on debt, prepare a brief summary explaining
what you feel will happen to your firm’s bond rating and borrowing costs on new debt funding
and the existing securities if they double the book value of long-term debt on the balance sheet.
This is not a formal memorandum. Just a few sentences, so that I can check your reasoning
against your empirical results.
Provide supporting documents on the firm’s income statements and balance sheets before and
after recapitalization (from Group Homework #9). Be sure to clearly state the rate that you are
assuming must be paid on the newly issued bonds to calculate the relevered income statement.
Also, provide the Excel spreadsheet showing your estimate of the market value and weightedaverage yield-to-maturity of the firm’s current long-term debt (from Group Homework #7). You
should now calculate the weighted-average time-to-maturity of the firm’s long-term debt in the
spread sheet if you have not already done so. Finally, provide any information from the CRVF
and CMX functions in the Bloomberg terminal that you use to estimate the rates on the firm’s
debt following recapitalization.
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