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Corporate Finance

Corporate Finance

Group Case Submission

Lyons Document Storage Corporation






Submitted by:
Group E11
Section E

Priyabrata Bisoi (0249/49)
Rahul Deb (0254/49)
Rahul Gautam (0255/49)
Satish Kumar (0301/49)

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Group Case Submission Term III

IIMC

Corporate Finance

Q1

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Lyons Document Storages controller, Eric Petro, told Rene that the bonds were issued in 1999 at a
discount and that only approximately $ 9.1 million was received in cash. Explain what is meant by
the terms premium or discount as they relate to bonds. Compute exactly how much the
company received from its 8% bonds if the rate prevailing at the time of the original issue was 9% as
indicated in Exhibit 2. Also re-compute the amounts shown in the balance sheet at December 31,
2006 and December 31, 2007, for Long-Term Debt. What is the current market value of the bonds
outstanding at the current effective interest rate of 6%?

Premium and discount are terms referring to the difference in face value of the bond
and the amount received by the borrower at the time of issue. Bonds selling at a price greater
than face value is said to be at a premium and the difference is called premium. If market rate
of interest is less than coupon rate, the bond can be issued at a premium.
Bonds selling at a price lesser than face value is said to be at a discount and the
difference is called discount. If market rate of interest is greater than coupon rate, the bond
can be issued at a discount.
The market rate at the time of issue was 9%, and the bond coupon rate was 8% paid
semi-annually(semi-annual payments of $4,00,000)Cash amount received by Lyons at the time
of issue is calculated by NPV(excel formula) using parameters 4.5%(rate), 40 coupon payments
of 400000 each and 10000000( face value) . The output comes out to be $ 90,79,920.78 which
is the amount received by Lyons Corp at the time of bond issue

Liability at
Liability at end of Liability at end of
Payment
Semi-Annual
Payment
beginning of
period before
period after
Date
Interest
period
payment
payment
02/01/00
400000
$ 90,79,920.78
$ 4,08,596.44
$ 94,88,517.21
$90,88,517.21
02/07/00
400000
$ 90,88,517.21
$ 4,08,983.27
$ 94,97,500.49
$90,97,500.49
02/01/01
400000
$ 90,97,500.49
$ 4,09,387.52
$ 95,06,888.01
$91,06,888.01
02/07/01
400000
$ 91,06,888.01
$ 4,09,809.96
$ 95,16,697.97
$91,16,697.97
02/01/02
400000
$ 91,16,697.97
$ 4,10,251.41
$ 95,26,949.38
$91,26,949.38
02/07/02
400000
$ 91,26,949.38
$ 4,10,712.72
$ 95,37,662.10
$91,37,662.10
02/01/03
400000
$ 91,37,662.10
$ 4,11,194.79
$ 95,48,856.90
$91,48,856.90
02/07/03
400000
$ 91,48,856.90
$ 4,11,698.56
$ 95,60,555.46
$91,60,555.46
02/01/04
400000
$ 91,60,555.46
$ 4,12,225.00
$ 95,72,780.45
$91,72,780.45
02/07/04
400000
$ 91,72,780.45
$ 4,12,775.12
$ 95,85,555.57
$91,85,555.57
02/01/05
400000
$ 91,85,555.57
$ 4,13,350.00
$ 95,98,905.57
$91,98,905.57
02/07/05
400000
$ 91,98,905.57
$ 4,13,950.75
$ 96,12,856.32
$92,12,856.32
02/01/06
400000
$ 92,12,856.32
$ 4,14,578.53
$ 96,27,434.86
$92,27,434.86
02/07/06
400000
$ 92,27,434.86
$ 4,15,234.57
$ 96,42,669.43
$92,42,669.43
02/01/07
400000
$ 92,42,669.43
$ 4,15,920.12
$ 96,58,589.55
$92,58,589.55
Group Case Submission Term III

IIMC

Corporate Finance

$ 92,58,589.55
$ 92,75,226.08
$ 92,92,611.26
$ 93,10,778.76
$ 93,29,763.81
$ 93,49,603.18
$ 93,70,335.32
$ 93,92,000.41
$ 94,14,640.43
$ 94,38,299.25
$ 94,63,022.71
$ 94,88,858.74
$ 95,15,857.38
$ 95,44,070.96
$ 95,73,554.15
$ 96,04,364.09
$ 96,36,560.48
$ 96,70,205.70
$ 97,05,364.95
$ 97,42,106.38
$ 97,80,501.16
$ 98,20,623.72
$ 98,62,551.78
$ 99,06,366.61
$ 99,52,153.11

$ 4,16,636.53
$ 4,17,385.17
$ 4,18,167.51
$ 4,18,985.04
$ 4,19,839.37
$ 4,20,732.14
$ 4,21,665.09
$ 4,22,640.02
$ 4,23,658.82
$ 4,24,723.47
$ 4,25,836.02
$ 4,26,998.64
$ 4,28,213.58
$ 4,29,483.19
$ 4,30,809.94
$ 4,32,196.38
$ 4,33,645.22
$ 4,35,159.26
$ 4,36,741.42
$ 4,38,394.79
$ 4,40,122.55
$ 4,41,928.07
$ 4,43,814.83
$ 4,45,786.50
$ 4,47,846.89

$ 96,75,226.08
$ 96,92,611.26
$ 97,10,778.76
$ 97,29,763.81
$ 97,49,603.18
$ 97,70,335.32
$ 97,92,000.41
$ 98,14,640.43
$ 98,38,299.25
$ 98,63,022.71
$ 98,88,858.74
$ 99,15,857.38
$ 99,44,070.96
$ 99,73,554.15
$ 1,00,04,364.09
$ 1,00,36,560.48
$ 1,00,70,205.70
$ 1,01,05,364.95
$ 1,01,42,106.38
$ 1,01,80,501.16
$ 1,02,20,623.72
$ 1,02,62,551.78
$ 1,03,06,366.61
$ 1,03,52,153.11
$ 1,04,00,000.00

$92,75,226.08
$92,92,611.26
$93,10,778.76
$93,29,763.81
$93,49,603.18
$93,70,335.32
$93,92,000.41
$94,14,640.43
$94,38,299.25
$94,63,022.71
$94,88,858.74
$95,15,857.38
$95,44,070.96
$95,73,554.15
$96,04,364.09
$96,36,560.48
$96,70,205.70
$97,05,364.95
$97,42,106.38
$97,80,501.16
$98,20,623.72
$98,62,551.78
$99,06,366.61
$99,52,153.11
$0.00

Using the above table, we can compute the long-term debt at the end of each period.

Balance sheet for Long term debt at December 31st 2006 = $92,58,589.55
Balance sheet for Long term debt at December 31st 2007= $92,92,611.26

Current market value of bonds at 6% market rate is $1,15,41,502.41(approx. $11.54 million)

Note: Above value found by the excel formula PV using parameters 3%(rate), 21 (number of
periods), 400000 (coupon payment), 10000000 (face value)

Group Case Submission Term III

IIMC

400000
400000
400000
400000
400000
400000
400000
400000
400000
400000
400000
400000
400000
400000
400000
400000
400000
400000
400000
400000
400000
400000
400000
400000
10400000

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02/07/07
02/01/08
02/07/08
02/01/09
02/07/09
02/01/10
02/07/10
02/01/11
02/07/11
02/01/12
02/07/12
02/01/13
02/07/13
02/01/14
02/07/14
02/01/15
02/07/15
02/01/16
02/07/16
02/01/17
02/07/17
02/01/18
02/07/18
02/01/19
02/07/19

Corporate Finance

Q2

Group Case Submission Term III

IIMC

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If you were Rene Cook, would you recommend issuing $10 million, 6% bonds on January 2, 2009 and
using the proceeds and other cash to refund the existing $10 million, 8% bonds? Will it cost more, in
terms of principal and interest payments, to keep the existing bonds or to issue new ones at a lower
rate? Be prepared to discuss the impact of a bond refunding on the following areas:
Cash flows
Current years earnings
Future years earnings
Note: For purpose of your computations, assume that refunding, if selected, occurs effective
January 2, 2009, at a price of $1,154.15 per bond. Ignore the effects of income taxes. How many
new $1,000 bonds will Lyons have to issue to refund the old 9% bonds?

The current market price of 8% bonds is $1,154.15 per bond. Cook needs $11.54 million
(1,154.15*10000) for retirement of old bonds. As the coupon rate is same as the current market rate
(6%) so each new bond will fetch $ 1000. $10 million will be available from the issuance of 10,000 new
bonds. This would require them to spend $1.54 million ($1541502.41) from their own pocket.


The impact of bond refunding on below three areas is

Cash Flows: Cook (Lyons) has to spend $ 1.54 million from its own pocket. However in later
periods, cash flow will improve, as it will have to pay $1,00,000 less every period (6 months)
for 20 periods due to lower coupon rate. It will also be paying interest for one less period.
Current Years earnings: It will show an outflow of $ 2.24 million as current liability was $ 9.3
million and the old bond were retired at $ 11.54 million (current market value)
Future years earnings: It will pay $ 100,000 less for the next 20 periods (1 period= 6 months)
and 1 interest payment less. So the future earnings will improve.

From calculations in excel sheet we found out
Saving in Principal by issue of new bonds
= [10000000/ (1.03^21)] - [10000000/ (1.03^20)] = -$ 1,61,264.783
Saving in Interest payments by issue of new bonds = $ 17,02,767.20

Sum of the above two equals the extra amount it has to pay now to retire old bonds. Taking into
account, Time Value of Money there is no difference in the PV of both options. So from accounting
standpoint, Cook can go ahead with either of the two options.

To retire the old bonds entirely by issuing new bonds, they have to issue 11542 new bonds (worth $
11.54 million) with 6% coupon rate paid semi-annually.

Corporate Finance

Q3

Assume 6% bonds could be issued and the proceeds used to refund the existing bonds. Compare the
effects of these transactions with those calculated in Question 2. If you were Rene Cook, what
amount of new bonds would you recommend and why?


The two options found from Q 2 are
i)
ii)

Issuing 10,000 new bonds and paying the remaining amount from own pocket
Issuing 11,542 new bonds to entirely finance, retirement of old bonds.

Since there is no difference in the PV of either alternative, from an accounting perspective, Cook
could be indifferent between either of the alternatives.
Option (i) requires a outflow of $ 1.54 million and will reflect a huge loss of $ 2.24 million in the current
year, which would be difficult to explain to the shareholders. Since David Lyons wouldnt be happy with
low earnings and shrinking growth rate so the above option was undesirable.

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Since David Lyons was interested in replacing 8 % bonds with bonds having lower interest rates,
therefore Cook should issue 11,542 new bonds to fully finance refunding of old bonds.

Group Case Submission Term III

IIMC