Heres a good question. A firm wishes to maximize its operating cash flows and minimize its debt to equity and interest coverage ratios. In order to accomplish all these objectives, instead of issuing conventional interest-bearing bonds at par, which of the following types of debt is the firm most likely to issue? A. Convertible bonds. B. Zero-coupon bonds. C. Bonds issued at a premium. D. Bonds with attached warrants. My only issue is with the answer, it states that the liability balance at issuance of a zero coupon bond would actually be higher than a regular par coupon bond ? This seems wrong. can anyone confirm this ? Discount bond liability would equal the proceeds of the issue which would certainly be less than the issue at par correct ?
B. Zero-coupon bonds. CFO will be overstated due to no interest being payed out. CFF will be understated since the bond is issued at a pure discount but the face value is $1000. The liability is $1000, but the funds received for finance are substantially less than that. Therefore, CFO will be higher over the life of the bond until maturity.
Wrong, however that is what I choose, correct answer is D but I like your confidence. my only problem with that answer was the text stated the liability recognized for the discount bond was higher than a regular bond which im almost certain is wrong.
Agree with ditch…liability will be face value… inorder for the company to achieve higher CFO, Zero is better but this does not address D2Equity issue. For Debt to Equity, I would prefer one w/ warrants as that is going to increase eq and decrease debt. Also Interest coverage is minimal in the latter case as opposed to the Zero. So D?
I was busy typing when you posted the answer… thanks jonny
The liability recorded for conventional bonds and convertible bonds is greater than for an equivalent amount of bonds with warrants attached. Because a portion of the proceeds ofa bond with attached warrens is classified as equity, both debt to equity and debt to total capital will be LOWER than if conventional or convertible debt were issued.