International Financial Risk Management
R.J. Reynolds International Financing HBS Case 9-287-057
The case is set in the context of RJR’s 1985 financing of its $4.9 billion acquisition of Nabisco Brands Inc. To finance the acquisition, RJR was proposing the issue of $1.2 billion of 12 year notes and the same amount in preferred stock. It had already funded $1.5 billion of the acquisition leaving $1 billion more to finance.
Challenges facing RJR: Of the $1.5 billion that had been funded, $500 million came from cash and the remaining was through bank borrowings and commercial paper. These borrowings added to the debt that RJR had issued in 1984 and brought their debt ratings down to A. The remaining $1 billion financing would have to keep this in mind as well as the $1.2 billion of 12 year notes to be funded. To determine the financing, we need to consider the following choices:
Debt vs. Equity: RJR is a mature company whose cash flows (> 1.5 billion in 1984) can support debt.
Short term vs. Medium to long term: Given their commercial paper and short term debt, and their long term debt, what is ideal for them at this juncture would be an issue of intermediate term (3-5 year) debt.
Fixed vs. Floating rate: The short term and commercial paper debt that they already have suggests using fixed rate debt.
Currency of financing: They do not have significant yen exposure that calls for exposure to yen liabilities
Domestic vs. foreign markets: Their current issues of debt have been in the domestic market so the foreign markets if attractive should certainly be considered.
Alternatives under consideration and their costs: (Refer to the spreadsheet gemi-rjr.xls for details on the calculations)
1. Eurodollar bonds: Most straightforward method that had an all-in cost of 10.59%. (This is the IRR of the cash flows associated with the bond issue to RJR taking into account the price (100.125% of par) and the investment banking fees of 1.875% and the annual coupon of 10.125%). The cost of 10.59% was at a 45 bp spread against U.S. Treasuries which was not a bad deal in itself. 2. Euroyen bonds: Since RJR would not have significant yen exposure, this bond made sense only when combined with some hedging tool that converted the yen payments to dollar payments. This can be done in two ways: a. Forward contracts arranged through a dealer such as Nikko Securities). The cash flows in yen and dollars via issue of a Euroyen bond and forward contracts to hedge the yen exposure are given below (also see spreadsheet): (initial cash inflows to RJR are converted using the offer rate and interest and principal payments or outflows are calculated using the bid rate from Exhibit 8) |Euroyen bond | Yen 25,000,000,000.00 | | |Year |Cash flows in Yen |Cash flows in dollars | |0 | 24,593,750,000.00 | 103,814,900.80 | |1 | -1,593,750,000.000 |- 6,890,402.08 | |2 | -1,593,750,000.000 |- 7,118,133.10 | |3 | -1,593,750,000.000 |- 7,392,161.41 | |4 | -1,593,750,000.000 |- 7,695,557.70 | |5 | -26,593,750,000.000 |- 134,583,755.06 |
The all-in cost (IRR) of this option in dollars is 10.64% and...