Scenario:Vacancy for ‘Finance Executive In-Charge of Debt Capital’
Sowers and Harvesters PLC, is a UK-based multinational business that produces heavy duty agricultural equipment and sells them into global markets. The firm has a large and appropriate balance of debt (bonds) in its capital structure and maintains a policy of raising increasing and balanced amounts of finance from both debt and equity markets to support its ambitious growth programmes. The firm remains open to taking advantage of cheaper forms of debt finance, and has from time to time called back more expensive bonds in favour of new issues that were cheaper. In pursuit of its ambitious programmes, and therefore the need to raise and manage more finance from the financial markets, the company has decided to appoint a full time finance-qualified person to manage its medium to long term debt finance processes to ensure efficiency in leveraging. Accordingly, the firm has advertised a vacancy for the position of ‘Finance Executive In-Charge of Debt Capital’. You have completed an undergraduate studies and obtained a degree in finance, and currently studying for the Chartered Financial Analyst (CFA) qualification. You saw the advert and applied. You have been shortlisted together with others to participate in the selection process. The first task in the process is for you to demonstrate, through report writing, a thorough knowledge and understanding of the bond market. The finance director, Mrs Grace Zheng, who will chair the panel of interviewers, has asked you to submit a report to be placed before the panel of interviewers. To serve as evidence of knowledge and understanding of the bond market your report should discuss, accurately, essential operations and aspects of the bond market with particular focus on interest rates as a source of income to investors and as a measure of ‘return on investments’ (yields). Specifically, your report should discuss the following items, explaining how, and the extent to which, knowledge and understanding of them may be relevant to the work of the finance executive to be appointed.
a)Bond characteristics, and bond quotes for different types of bonds.(300 words).
b)Factors that may influence coupon rates (selectnot more thanthree factors).(300 words).
c)The calculation oftwo typesof bond yields, namely, (i)either‘yield to maturity’or‘yield to call’,and(ii) ‘equivalent tax yield’.(300 words).
Required:
(a)Prepare a report to be presented to Mrs Grace Zheng, the director of finance and chair of the selection committee. You should analyse and evaluate issues to be covered in the report as suggested in ‘a’ to ‘c’ above. Where appropriate, provide figures, tables and worked examples to illustrate different aspects/issues in your report as you may see need.
(b)In addition to above you are to discuss/demonstrate the extent to which your knowledge and understanding of capital investment appraisal (on the basis of size of investment, number of years, and cost of capital) may influence your recommendations to the finance director regarding the issue/sale of bonds in the capital market. You may be guided by your knowledge and understanding of the use of Net Present Value (NPV) and/or Pay Back methods.(350 words).
(c)If, instead of a combination of both debt and equity capital or debt capital only, the management ofSowers and Harvesters PLC decides to use equity capital only to finance its investment projects, cost of capital will be higher and may probably lead to the rejection of some exclusive projects when the high cost of capital is used as the discount rate. Explain and demonstrate why equity cost of capital is higher than debt forms of capital.(250 words).