Buckner Industries has prepared the condensed forecast income statement for the year ending December 31, 2002.

After creating the forecast, Buckner develops a new product, which will require $100 million in additional capital expenditures at the beginning of 2002. With the new product, EBIT in 2002 is expected to be 15 percent higher than the amount forecast in Exhibit above. To finance the increase in the capital budget, Buckner is considering a plan using 50 percent equity and 50 percent long-term debt. New equity would be issued at $25.00 net proceeds per share and the interest rate on the new long-term debt would be 8.50 percent. Buckner is reviewing how this financing, if completed on December 31, 2001, would affect the companys EPS.

A. Construct a pro forma income statement (I/S) for 2002, assuming the financing plan is adopted.

Instead of using 50 percent equity and 50 percent long-term debt, Buckner decides to finance the entire capital budget increase by issuing $100 million in new long-term debt.

Jack Deven, a fixed income portfolio manager with LightStreet Investments, is concerned about the effect of such a large debt issuance on Buckners s credit quality and calculates selected pro forma financial credit quality ratios, shown in Exhibit below. LightStreet owns previously issued option-free Buckner bonds in its U.S. Corporate Bond portfolio. These bonds have a 10-year maturity and a modified duration of 6.5 years.

Deven wants to compare his recalculated credit ratios to LightStreets credit quality standards, also shown in Exhibit below. Buckner satisfied each of these credit quality standards prior to the new debt issue. For each standard no longer satisfied after the new debt issue, Deven believes the yield on the previously issued Buckner bonds will increase by 10 basis points.

B.

i. Identify the ratios that would contribute to an increase in the total yield on the previously-issued Buckner bonds if Devens analysis is correct.

ii. Calculate the direction and magnitude of the percentage price change due to the change in yield. Show your calculations.

Buckner Industries Condensed Forecast Income Statement Year Ending December 31, 2002 (in thousands except for per share data) Earnings Before Interest and Taxes (EBIT) Interest Expense Pretax Income Income Taxes (30% tax rate) Net Income Shares Outstanding Earnings Per Share (EPS) $94,500 11,000 $83.500 25,050 $58,450 12,000 $4.87