Case Study

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De La Salle Professional Schools Inc.

Peachtree Securities, Inc. (B) A Case Analysis

Submitted to: Prof. Benel Lagua

In Partial Fulfillment of the Course Requirement In Financial Management

Submitted by: Cheng, Cindie Domo-ong, Kathleen Mendoza, Elissa Santos, Ana Liza Group 4 August 28, 2010

After a successful lecture on risk and return, Laura Donahue, a recently hired utility analyst for Peachtree Securities, Inc., was tasked by its president, Jack Taylor, to determine the value of TECO Energy’s securities (common stock, preferred stock and bonds) and then conduct a seminar to explain the process to the firm’s customers. To do this, Laura first reviewed the Value Line Investment Survey data and examined TECO’s latest Annual Report, especially Note E of its Consolidated Financial Statements (lists TECO’s long-term debt obligations, including its first-mortgage bonds, installment contracts and term loans, See Table 1). Table 1: Partial Long-term Debt Listing for TECO Energy. Face Amount $ 48,000,000 32,000,000 100,000,000 Coupon Rage 4.5% 8.25 12.625 Maturity Year 1997 2007 2017 Years to Maturity 5 15 25

A current concern that is plaguing the industry is a phenomenon called “Event risk”. This is when the credit rating of a firm’s existing bonds drop, its required rate of return increase and then its price of bonds decline. This is the effect due to the high-risk “junk” bonds issued to finance leveraged buyouts (LBOs) and debt-financed corporate takeovers. Seeing this is trend, Laura was tasked to see if this could affect the required returns on TECO’s outstanding bonds. To do this, she will have to answer the following questions:

1. To begin, assume that it is now January 1, 1993 , and that each bond in Table 1 matures on December 31 of the year listed. Further, assume that each bond has a $1,000 par value, each had a 30-year maturity when it was issued, and the bonds currently have a 10 percent required nominal rate of return 1a . Why do the Bond's coupon rates vary so widely? The Coupon Rate is the interest rate that the issuer agrees to pay each year. This payment, which is fixed at the time the bond is issued, remains in force during the life of the bond. Interest rates have risen over the last 25 years, and that explains the rising pattern of the coupons rates.

1b. What would be the value of each bond if they had annual coupon payments?

1c. TECO'S bonds, like virtually all bonds, actually pay interest semiannually. What is each bond's value under these conditions? Are the bonds currently selling at a discount or a premium? To compute for the semi-annual rates: 1. Divide the annual coupon interest payment by 2 to determine the dollars of interest paid each six months 2. Multiply the years to maturity, N, by 2 to determine the number of semiannual periods 3. Divide the nominal interest rate, kd by 2 to determine the semiannual interest rate

• •

Discount - Amount by which the Market Price of a bond is lower than its Face Value. Premium - Amount the purchaser pays in buying a bond that exceeds the face or call value of the bond.

1d. What is the effective annual rate of return implied by the values obtained in Part C?

EAR = EFF% = (1+Knom/m)m – 1

1e. Would you expect a semiannual payment bond to sell at a higher or lower price than an otherwise equivalent annual payment bond? Now look at the 5-year bond in Parts b and c. Are the prices shown consistent with your expectations? Explain. • Semiannual interest payments is slightly larger than the value when interest is paid annually. This higher value occurs because interest payments are received somewhat faster under semi-annual compounding.

2. Now regardless of your answers to Question 1, assume that the 5-year bond is selling for $800.00, the 15-year bond is selling for $ 865.49, and the 25-year bond is selling for $1,220.00 2a. Explain the meaning of the term "yield to maturity". Yield to Maturity is the rate of return...
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