1 Case 1 - General Electric Standard & Poor's currently rates General Electric's (GE) debt as BBB GE's capital structure includes the following debt securities: 2040 2050 Principal Due Coupon Base Description Type (USD) Rate Maturity 4.250% Notes Due 2040 Bonds and Notes 748.0 4.250% 4.350% Notes Due 2050 Bonds and Notes 1,277.0 4.350% Current Portion of Long Other Borrowings 1,002.0 5.030% Sep-30-2022 Term Borrawings Senior Unsecured Debt- Bonds and Notes 1,000.0 3.450% 2027 3.450% Notes Due 2027 Senior Unsecured Debt Bonds and Notes 1,250.0 3.625% 2030 3.625% Notes Due 2030 On 9 November 2021, GE announced that they plan to split into 3 separate companies. In early 2023, the company will have a tax-free spin-off of its health care operations and in 2024 will spin-off the GE Renewable Energy, GE Digital, and GE power into another company. This will leave GE has an aviation focused company. (See the press release, "GE Plans to Form Three Public Companies Focused on Growth Sectors of Aviation, Healthcare, and Energy." Shortly after the announcement went public, S&P Global Ratings announced that it would place GE's bonds under review for a possible downgrade because spinning off the healthcare operations leaves GE less diversified. (Lipoane, C., 9 November 2021, "S&P Global Ratings puts GE ratings on review for possible downgrade after plan to split into three companies", Market Watch) As provided above, GE's credit rating is currently BBB. Assume that GE's debt is downgraded one grade to BB. Current yields for both BBB and BB rated bonds are: Term 1-year 5-year 6-year 7-year 8-year 9-year 10-year 19-year 29-year Based on this information answer the following questions: 1. Which do you think will happen first: investors re-price GE's bonds or S&P changes the ratings on the bonds? Explain why. 2. Explain the implications of moving from a BBB-rated bond to a BB-rated bond. 3. Calculate the value of GE's bonds both before and after the change in bond ratings. 4. Identify the bonds that have the greatest change in value. Explain why those bonds had the greatest change in value. 5. Assume the potential bond rating change has no effect on GE's equity. Explain how the rating change affects GE's cost of capital and why. 6. Is the assumption in (5) accurate? Explain why the bond rating change will have an effect on BBB 0.999% 2.30% 2.50% 2.68% 2.84% 2.98% 3.10% 3.75% 3.84% BB 2.05% 3.76% 4.05% 4.31% 4.54% 4.74% 4.93% 5.91% 6.08% GE's beta. 1 Case 1 - General Electric Standard & Poor's currently rates General Electric's (GE) debt as BBB GE's capital structure includes the following debt securities: 2040 2050 Principal Due Coupon Base Description Type (USD) Rate Maturity 4.250% Notes Due 2040 Bonds and Notes 748.0 4.250% 4.350% Notes Due 2050 Bonds and Notes 1,277.0 4.350% Current Portion of Long Other Borrowings 1,002.0 5.030% Sep-30-2022 Term Borrawings Senior Unsecured Debt- Bonds and Notes 1,000.0 3.450% 2027 3.450% Notes Due 2027 Senior Unsecured Debt Bonds and Notes 1,250.0 3.625% 2030 3.625% Notes Due 2030 On 9 November 2021, GE announced that they plan to split into 3 separate companies. In early 2023, the company will have a tax-free spin-off of its health care operations and in 2024 will spin-off the GE Renewable Energy, GE Digital, and GE power into another company. This will leave GE has an aviation focused company. (See the press release, "GE Plans to Form Three Public Companies Focused on Growth Sectors of Aviation, Healthcare, and Energy." Shortly after the announcement went public, S&P Global Ratings announced that it would place GE's bonds under review for a possible downgrade because spinning off the healthcare operations leaves GE less diversified. (Lipoane, C., 9 November 2021, "S&P Global Ratings puts GE ratings on review for possible downgrade after plan to split into three companies", Market Watch) As provided above, GE's credit rating is currently BBB. Assume that GE's debt is downgraded one grade to BB. Current yields for both BBB and BB rated bonds are: Term 1-year 5-year 6-year 7-year 8-year 9-year 10-year 19-year 29-year Based on this information answer the following questions: 1. Which do you think will happen first: investors re-price GE's bonds or S&P changes the ratings on the bonds? Explain why. 2. Explain the implications of moving from a BBB-rated bond to a BB-rated bond. 3. Calculate the value of GE's bonds both before and after the change in bond ratings. 4. Identify the bonds that have the greatest change in value. Explain why those bonds had the greatest change in value. 5. Assume the potential bond rating change has no effect on GE's equity. Explain how the rating change affects GE's cost of capital and why. 6. Is the assumption in (5) accurate? Explain why the bond rating change will have an effect on BBB 0.999% 2.30% 2.50% 2.68% 2.84% 2.98% 3.10% 3.75% 3.84% BB 2.05% 3.76% 4.05% 4.31% 4.54% 4.74% 4.93% 5.91% 6.08% GE's beta