Question 2 To fund some of its expansion plans, Melbourne Rubber & Tyre (MRT) recently issued 30- year bonds with low coupon rates. Investors were willing to purchase the bonds despite the low coupon rates because MRT's debt has consistently been rated AA or higher during the past decade, which means that bond rating agencies consider the company's default risk to be extremely low. Now MRT is considering raising additional funds by issuing new debt. The company plans to use the new funds to finance additional expansion. Unlike with its previous expansion efforts, MRT now plans to grow the company by purchasing young companies that have recently gone public and that are not in the tyre and rubber industry. Wally, who works closely with MRT's investment banker, has been assigned the task of determining how to best raise the desired funds. After speaking with the investment banker, some friends who work at other companies and peers in MRT's international subsidiaries, Wally is seriously considering recommending to management that MRT issue a new security that has the characteristics of both debt and equity. The security, which was recently introduced in Australian financial markets, is classified as debt because fixed interest payments that are tax deductible are paid every year. Unlike conventional bonds, these hybrid bonds, called bondares', have maturities of 50 to 60 years. In addition, the company is not considered to be in default if it misses interest payments when the company's credit rating drops below B+. Most experts consider bondares to be quite complex financial instruments. Through his research, Wally discovered that bondares have been used for quite some time outside of Australia. Compared with conventional debt, companies that have used bondares have increased their earnings per share (EPS) significantly. A major reason EPS increases is because the cost of a bondare generally is much lower than equity, but the instrument is comparable to equity financing with respect to maturity and default risk. For example, Wally discovered that MRT could issue bondares with an after-tax cost equal to 5 ner cent, which is Question 2 To fund some of its expansion plans, Melbourne Rubber & Tyre (MRT) recently issued 30- year bonds with low coupon rates. Investors were willing to purchase the bonds despite the low coupon rates because MRT's debt has consistently been rated AA or higher during the past decade, which means that bond rating agencies consider the company's default risk to be extremely low. Now MRT is considering raising additional funds by issuing new debt. The company plans to use the new funds to finance additional expansion. Unlike with its previous expansion efforts, MRT now plans to grow the company by purchasing young companies that have recently gone public and that are not in the tyre and rubber industry. Wally, who works closely with MRT's investment banker, has been assigned the task of determining how to best raise the desired funds. After speaking with the investment banker, some friends who work at other companies and peers in MRT's international subsidiaries, Wally is seriously considering recommending to management that MRT issue a new security that has the characteristics of both debt and equity. The security, which was recently introduced in Australian financial markets, is classified as debt because fixed interest payments that are tax deductible are paid every year. Unlike conventional bonds, these hybrid bonds, called bondares', have maturities of 50 to 60 years. In addition, the company is not considered to be in default if it misses interest payments when the company's credit rating drops below B+. Most experts consider bondares to be quite complex financial instruments. Through his research, Wally discovered that bondares have been used for quite some time outside of Australia. Compared with conventional debt, companies that have used bondares have increased their earnings per share (EPS) significantly. A major reason EPS increases is because the cost of a bondare generally is much lower than equity, but the instrument is comparable to equity financing with respect to maturity and default risk. For example, Wally discovered that MRT could issue bondares with an after-tax cost equal to 5 ner cent, which is

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