DryEden manufactures water-saving products for the home in anticipation of widespread water shortages. The company is planning to expand its operations by building a new facility in Arizona, which will be financed by issuing $350 million in 20-year bonds. The bonds will pay interest at a rate that approximates the return investors will require for new DryEden bonds. The bonds will pay interest twice per year.

Required:

a. Identify three or four major pieces of information that investors will use when deciding what return they expect from DryEden bonds at this time. Explain the significance of each.

When deciding what return they expect from DryEden bonds at this time, investors will consider several pieces of information, including:

Creditworthiness of DryEden: Investors will evaluate DryEden's creditworthiness and credit rating to determine the likelihood of default and the associated risk.

Economic and industry conditions: Investors will consider the current economic conditions and the state of the water-saving products industry, including trends in demand and supply, competition, and regulatory environment.

Bond terms and conditions: Investors will review the terms and conditions of the bonds, including maturity, coupon rate, payment frequency, and other covenants.

Overall market conditions: Investors will assess the overall market conditions, including interest rate trends, inflation expectations, and geopolitical risks.

b. DryEden and its investment bank have agreed that the market will probably demand about a 7.3% return at this time and have set the bonds coupon rate at 7.5% to make it look attractive to investors. At the time of issuance, however, the market actually demands a return of 8.8% from this company. Show calculations for the bonds issue price given this information.

Calculation of the bond's issue price:

Coupon rate = 7.5%

Market return = 8.8%

Face value = $350 million

Payment frequency = Semi-annual

Time to maturity = 20 years

Number of coupon payments = 40 (20 years x 2 payments per year)

First, we need to calculate the semi-annual coupon payment:

Coupon payment = (Coupon rate x Face value) / Number of payments per year

Coupon payment = (7.5% x $350 million) / 2

Coupon payment = $13,125,000

Next, we can calculate the present value of the bond's cash flows using the market return as the discount rate:

Present value of coupon payments = Coupon payment x [1 - 1 / (1 + (Market return / 2))^Number of coupon payments] / (Market return / 2)

Present value of coupon payments = $13,125,000 x [1 - 1 / (1 + (8.8% / 2))^40] / (8.8% / 2)

Present value of coupon payments = $181,359,865.47

To calculate the present value of the bond's face value, we can use the same formula:

Present value of face value = Face value / (1 + (Market return / 2))^Number of coupon payments

Present value of face value = $350 million / (1 + (8.8% / 2))^40

Present value of face value = $108,576,658.91

The issue price of the bond can be calculated as the sum of the present value of the coupon payments and the present value of the face value:

Issue price = Present value of coupon payments + Present value of face value

Issue price = $181,359,865.47 + $108,576,658.91

Issue price = $289,936,524.38

Therefore, the bond's issue price given the market's demand for an 8.8% return is $289,936,524.38.

c. If the companys estimated return rate of 7.3% had been accurate, how much more or less cash would the bond issue have raised? Explain the difference.

If the company's estimated return rate of 7.3% had been accurate, the bond issue would have raised more cash. The issue price would have been higher, reflecting the lower market return, which would have increased the present value of the bond's cash flows. The difference in cash raised would depend on the exact issue price and would be equal to the issue price calculated using a 7.3% discount rate minus the issue price calculated using an 8.8% discount rate.