2 eBook: Principles eBook: Principles of Finance Q TT Finance Quick Tour Print Search Annotations Accessibility Bookmark of Finance ETHICAL DILEMMA Capital Structures and Dividend Policies around 582 A Bond Is a Bond Is a Bond ... Is a Stock ... Is a Bondock? the World To fund some of its expansion have used bondocks have increased their EPS signifi- Questions 587 plans, Ohio Rubber & Tire cantly. A major reason EPS increases is the cost of a (ORT) recently issued 30-year bondock generally is much lower than equity, but the Problems 589 bonds with low coupon rates. Investors were willing to instrument is comparable to equity financing with respect purchase the bonds despite the low coupon rates because to maturity and default risk. For example, Wally discov- ORT's debt has consistently been rated AAA during the ered that ORT could issue bondocks with an after-tax Computer-Related 596 Problems past decade, which means that bond rating agencies con- cost equal to 5 percent, which is only slightly higher sider the company's default risk to be extremely low. than the after-tax cost of issuing conventional debt and Now ORT is considering raising additional funds by is approximately one-third the cost of issuing new equity. Appendix 14A 597 issuing new debt. The company plans to use the new Although bondocks are considered risky, the actual funds to finance additional expansion. Unlike its previous degree of risk is unknown. The friends and coworkers Ch 15: Working Capital expansion efforts, however, ORT now plans to grow the with whom Wally consulted seem to think that there is a 599 Management firm by purchasing young firms that just "went public" slight chance that investors-both stockholders and and are not in the tire and rubber industry. bondholders-would earn returns significantly lower Part 5: Investor Decision Wally, who works closely with ORT's investment than would be earned with conventional debt when the 649 Making banker, has been assigned the task of determining how company performs extremely poorly. The opposite to best raise the desired funds. After speaking with the should occur when the company performs very well. investment banker, some friends who work at other The major drawback to issuing bondocks is that they Appendix A: Using companies, and peers in ORT's international sub- will significantly increase the financial leverage of ORT, Spreadsheets to Solve 735 Financial Problems sidiaries, Wally is seriously considering recommending and thus the value of the recently issued bonds will to management that ORT issue a new security that has decrease substantially. On the other hand, Wally thinks the characteristics of both debt and equity. The security, that issuing bondocks can be a win-win proposition for Appendix B: Answers to 747 which was just recently introduced in the U.S. financial ORT and its common stockholders. If the company's End-of-Chapter Problems markets, is classified as debt because fixed interest expansion plans are successful, stockholders will be navments that are tax deductible are naid every vear nicely rewarded. If the company's expansion plans are Jump to Page 584 / 818