Question
Luxe Vacation is a restaurant and spa chain located in New Jersey. Aimed to adopt high technology, Luxe Vacation urgently needs to raise funds to
Luxe Vacation is a restaurant and spa chain located in New Jersey. Aimed to adopt high technology, Luxe Vacation urgently needs to raise funds to renovate the infrastructure. Should they choose to issue bonds or stocks? Here are the details for your evaluation:
a. Luxe Vacation's bonds have a credit rating of AAA. The market yield-to-maturity rate for AAA bonds is 3.75%. Luxe Vacation's debt to value ratio is 50%, which is relatively low for this specific industry. Luxe Vacation's total market value of debt is $900,000. Luxe Vacation plans to issue 500 annual coupon bonds with the par value of $1,000, 5-year to maturity, and a coupon rate of 4.5%. What is the price of this bond?
b. If Luxe Vacation issues bonds, the total market value of debt is $1,400,000 (an additional 500 bonds with the par value of $1,000 each). The new debt to value ratio is 77.77%, which brings down the credit rating of Luxe Vacation's bonds to AA. The market yield-to-maturity for AA bonds is 4.25%. What is the new price of this bond?
c. Luxe Vacation has never issued stock before, so there is no historical information about this company's cost of capital. However, Luxe Vacation's financial analyst found the equity rate of return from their direct competitor is 12%. If next year's dividend expectation is $6/share and the growth rate is 5%, what is the Luxe Vacation's share price in today's dollar?
d. Luxe Vacation plans to issue 10,000 shares. What is the total amount of raised funds from this issue?
e. Comparing the raised funds between the two options: issuing stocks and issuing bonds. Which option should they choose? And why?
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