Download Question 1 Over the past quarter XYZ company`s performance has

Question 1
Over the past quarter XYZ company’s performance has improved greatly. XYZ has gone
from a BBB bond rating to an AA bond rating. Currently, XYZ has $5,000,000 in
callable bonds outstanding at a stated rate of 8 percent with a maturity rate of 10 years.
The bonds are callable at 103. The new market rate for AA bonds is 6 percent.
Should XYZ call the bonds and reissue them because of the new bond rating? Why or
why not? Are bond ratings applicable for all companies? Why?
Question 2
You are considering investing $10,000 in ABC’s bonds. Right now the stated rate of the
bonds is seven percent, and the market rate is eight percent. The Federal Reserve System
is considering lowering the interest rate by two percent to help stimulate the economy
sometime next year, but the final decision has not been made (or at least publically
announced).
Should you invest in the bonds now or wait until the Federal Reserve System makes its
announcement? What is your reasoning behind your decision? What affect will this have
on ABC’s financial statements? How long should you hold the bonds if you choose to
invest?
Yes the investment should be as it would be available at discounted price due to higher
market interest rate, and when the announcement will be made of reduction of 2% it is
expected that market value of bond will go up. The company should hold it till the
decision is made to have capital gain. It will increase the profit by capital gain and
financial statement will show higher profit.
Question 3
You own a small publically held company and are in need of raising new capital. You
want to issue new shares of stocks but are unsure which type of stock to issue. You
currently have 1,000,000 shares of common stock and 200,000 shares of preferred stock
authorized. As of today, only 250,000 shares of common stock and 50,000 shares of
preferred stock are outstanding.
What are the advantages and disadvantages of issuing both types of shares? Which type
of shares would you decide to issue and why? What affect would the new issuance have
on the financial statements?
The preferred stock has no voting rights and has the fixed rate of dividend. The
common stock has voting rights and no fixed rate of dividend. Dividend is to be paid in
either case if company makes profit. Normally the preferred stock is not preferred by
the investors, they are reluctant to subscribe the preferred stock. It depends on the past
record of the company if company has good record of paying dividend on common
stock and past dividends on common stock is more than preferred stock then it is
preferable to issue common stock, otherwise common stock should be issued.
The shareholder equity will increase in either case in terms of dollars. However the
earnings per share will be lower if preferred stocks are issued and it will be higher if
common stocks are issued.
If the common stock or preferred stock are issued at price more than the present book
value of common stock or par value of preferred stock the new book value of common
stock will increase. If they are issued at lower value the book value will decrease and if
they are issued at present book value or par value then there will be no change in the
new book value of common stock.