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    Financial Leverage with external funding

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    A company is trying to raise $43 million of external funding. Would there be financial leverage and what kind of financial leverage would be present if a company could issue bonds in the capital market, preferring a bond issue over bank financing because of the restrictions the bank imposes with its standard loan covenants. Among the restrictions would be a prohibition on the acquisition of other companies while the loan is outstanding. If the company plans to continue its 14% rate of growth through acquisitions and such a restriction would force the company to develop a new strategic plan. A sinking fund will be invested at 5% annual interest, the annual payments that must be contributed to the account for each of the ten years is $3,418,696.72 and the company can expect to see the following proceeds at each one of the following rates:

    7.00% $34,511,174.73
    7.50% $35,818,354.48
    8.00% $37,125,534.22
    8.50% $38,432,713.97
    9.00% $39,739,893.71
    9.25% $40,393,483.59
    9.50% $41,047,073.46
    10.00% $42,354,253.21
    10.25% $43,000,000.00
    10.50% $43,661,432.95

    What rate would they issue the bonds? And what kind of financial leverage would the company have be issuing these bonds?

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    Solution Preview

    In this problem, we have to first find out how much amount can the sinking fund repay. We know what amount we contribute every month and the interest we get. Using the FV annuity formula, this grows to $43,000,000 at the end of 10 ...

    Solution Summary

    The solution provides the calculation for the amount of financing that should be raised as bonds given the expected cash flows and the impact on financial leverage