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After Dans EFN analysis for East Coast Yachts (see the Mini Case in Chapter 3), Larissa has decided to expand the companys operations. She has asked Dan to enlist an underwriter to help sell $50 million in new 20-year bonds to finance new construction. Dan has entered into discussions with Kim McKenzie, an underwriter from the firm of Crowe & Mallard, about which bond features East Coast Yachts should consider and also what coupon rate the issue will likely have. Although Dan is aware of bond features, he is uncertain as to the costs and benefits of some of them, so he isnt clear on how each feature would affect the coupon rate of the bond issue.

1. You are Kims assistant, and she has asked you to prepare a memo to Dan describing the effect of each of the following bond features on the coupon rate of the bond. She would also like you to list any advantages or disadvantages of each feature.

a. The security of the bond, that is, whether or not the bond has collateral.

b. The seniority of the bond.

c. The presence of a sinking fund.

d. A call provision with specified call dates and call prices.

e,. A deferred call accompanying the above call provision.

f. A make-whole call provision.

g. Any positive covenants. Also, discuss several possible positive covenants East Coast Yachts might consider.

h. Any negative covenants. Also, discuss several possible negative covenants East Coast Yachts might consider.

i. A conversion feature (note that East Coast Yachts is not a publicly traded company).

j. A floating rate coupon.

Dan is also considering whether to issue coupon bearing bonds or zero coupon bonds. The YTM on either bond issue will be 7.5 percent. The coupon bond would have a 6.5 percent coupon rate. The companys tax rate is 35 percent.

2. How many of the coupon bonds must East Coast Yachts issue to raise the $50 million? How many of the zeroes must it issue?

3. In 20 years, what will be the principal repayment due if East Coast Yachts issues the coupon bonds? What if it issues the zeroes?

4. What are the companys considerations in issuing a coupon bond compared to a zero coupon bond?

5. Suppose East Coast Yachts issues the coupon bonds with a make-whole call provision. The make-whole call rate is the Treasury rate plus .40 percent. If East Coast calls the bonds in seven years when the Treasury rate is 4.8 percent, what is the call price of the bond? What if it is 8.2 percent?

6. Are investors really made whole with a make-whole call provision?

7. After considering all the relevant factors, would you recommend a zero coupon issue or a regular coupon issue? Why? Would you recommend an ordinary call feature or a make-whole call feature? Why?

Mini Case (from Chapter 3 listed below)

Dan Ervin was recently hired by East Coast Yachts to assist the company with its short-term financial planning and also to evaluate the companys financial performance. Dan graduated from college five years ago with a finance degree, and he has been employed in the treasury department of a Fortune 500 company since then.

East Coast Yachts was founded 10 years ago by Larissa Warren. The companys operations are located near Hilton Head Island, South Carolina, and the company is structured as an LLC. The company has manufactured custom midsize, high-performance yachts for clients over this period, and its products have received high reviews for safety and reliability. The companys yachts have also recently received the highest award for customer satisfaction. The yachts are primarily purchased by wealthy individuals for pleasure use. Occasionally, a yacht is manufactured for purchase by a company for business purposes.

The custom yacht industry is fragmented, with a number of manufacturers. As with any industry, there are market leaders, but the diverse nature of the industry ensures that no manufacturer dominates the market. The competition in the market, as well as the product cost, ensures that attention to detail is a necessity. For instance, East Coast Yachts will spend 80 to 100 hours on hand-buffing the stainless steel stem-iron, which is the metal cap on the yachts bow that conceivably could collide with a dock or another boat.

To get Dan started with his analyses, Larissa has provided the following financial statements. Dan has gathered the industry ratios for the yacht manufacturing industry.

East Coast Yachts

2015 Income Statement

Sales $210,900,000

Costs of goods sold 148,600,000

Other expenses 25,192,000

Depreciation 6,879,000

Earnings before interest and taxes $30,229,000

Interest 3,791,000

Taxable Income $26,438,000

Taxes (40%) 10,575,200

Net Income $15,862,800

Dividends $4,759,301

Add to RE $11,103,499

East Coast Yachts

Balance Sheet as of December 31, 2015

Assets Liabilities & Equity

Current Assets Current liabilities

Cash $3,285,600 Accounts payable $6,977,700

Accounts Receivable 5,910,800 Notes Payable 14,342,600

Inventory 6,627,300 Total $21,320,300

Total $15,823,700

Fixed assets Long-term debt $36,400,00

Net plant and equip. $101,481,200 Shareholders' equity

Common stock $5,580,000

Retained earnings 54,004,600

Total equity $59,584,600

Total assets $117,304,900 Total liabilities and equity $117,304,900

Yacht Industry Ratios

Lower Quartile Median Upper Quartile

Current ratio .50 1.43 1.89

Quick ratio .21 .38 .62

Total asset turnover .68 .85 1.38

Inventory turnover 6.85 9.15 16.13

Receivable turnover 6.27 11.81 21.45

Debt ratio .44 .52 .61

Debt-equity ratio .79 1.08 1.56

Equity multiplier 1.79 2.08 2.56

Interest coverage 5.18 8.06 9.83

Profit margin 4.05% 6.98% 9.87%

Return on assets 6.05% 10.53% 15.83%

Return on equity 9.93% 16.54% 28.14%