Question 1. SkyTech Ltd., operating in the aerospace technology sector, is considering raising 200 million in the bond market to finance the acquisition of a satellite manufacturing facility. The debt will mature in four years, with interest payments made annually. The current market value of SkyTech Ltd.'s equity stands at 1.5 billion, and the company maintains a market gearing ratio of 30% (market value of debt to total market value of the firm). SkyTech Ltd.'s existing debt has an average annual coupon rate of 4% and is set to mature in three years . The company's effective tax rate is 30% The prevailing yield curve indicates that three-year government bonds yield 3.6% , while four-year bonds yield 5.2% . The estimated credit risk spread is 50 basis points. If the bond issuance proceeds, the company's bankers advise that a 90 basis point spread will be necessary to ensure full subscription by institutional investors at a nominal value of 100 1) Advise on the coupon rate that should be applied to the new debt issue to ensure that it is fully subscribed. 2) Estimate the current and revised market valuation of Sea Cruise Co.'s debt and the increase in the company's effective cost of debt.

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Question 1. SkyTech Ltd., operating in the aerospace technology sector, is considering raising 200 million in the bond market to finance the acquisition of a satellite manufacturing facility. The debt will mature in four years, with interest payments made annually. The current market value of SkyTech Ltd.'s equity stands at 1.5 billion, and the company maintains a market gearing ratio of 30% (market value of debt to total market value of the firm). SkyTech Ltd.'s existing debt has an average annual coupon rate of 4% and is set to mature in three years . The company's effective tax rate is 30% The prevailing yield curve indicates that three-year government bonds yield 3.6% , while four-year bonds yield 5.2% . The estimated credit risk spread is 50 basis points. If the bond issuance proceeds, the company's bankers advise that a 90 basis point spread will be necessary to ensure full subscription by institutional investors at a nominal value of 100 1) Advise on the coupon rate that should be applied to the new debt issue to ensure that it is fully subscribed. 2) Estimate the current and revised market valuation of Sea Cruise Co.'s debt and the increase in the company's effective cost of debt.

Answer 1

1) To determine the coupon rate that should be applied to the new debt issue to ensure full subscription, we need to consider the prevailing yield curve, the estimated credit risk spread, and the bankers' advice on the spread.The prevailing yield curve indicates that three-year government bonds yield 3.6%, while four-year bonds yield 5.2%. The estimated credit risk spread is 50 basis points, which means the yield on the company's existing debt is 4.5% (4% + 0.5%).Given that the new debt will mature in four years, we need to consider the yield on four-year bonds. The bankers' advice is that a 90 basis point spread will be necessary to ensure full subscription. Therefore, the coupon rate for the new debt issue should be 5.2% + 0.9% = 6.1%.2) To estimate the current and revised market valuation of SkyTech Ltd.'s debt and the increase in the company's effective cost of debt, we need to calculate the market value of the existing debt and the new debt issue.The market gearing ratio is 30%, which means the market value of debt is 30% of the total market value of the firm. The total market value of the firm is

450 million.The effective cost of debt is calculated by taking the average annual coupon rate and adjusting it for taxes. The effective cost of debt for the existing debt is 4% * (1 - 0.3) = 2.8%.After issuing the new debt, the market value of debt will increase to

450 million + $100 million). The yield on the new debt issue is 6.1%, so the effective cost of debt for the new debt issue is 6.1% * (1 - 0.3) = 4.27%.The increase in the company's effective cost of debt is 4.27% - 2.8% = 1.47%.

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