Sdi Case

Summary of Case

SDI is a manufacturing company of equipment to sell to large contractors. The recent performance of SDI has not been good, to the put where analysts believe that the company will cut its annual dividend in 1997. The operating results of the company have been poor, so Tony Biddle, a security analyst that follows SDI, has provided some information about the company for analysis. SDI would like estimates of debt and preferred stock, as well as the marginal investor’s expected return. These reasonable estimates must be presented to the SDI executives in order for them to develop accurate values for EVA and a good cost of capital estimate.

Question 1

If an investor bought some of SDI’s A bonds at the current market price, what would be his or her yield to maturity?

Response: 8.61% YTM

A Bond

PMT $ 50.00

PV $1,092.00

FV $1,000.00

N 20

I 8.61%

Question 2

Like many other bonds, SDI’s A bonds have a call provision. What is the yield to call on this issue? Which return would an investor be more likely to receive on this bond if it were purchased today, the YTM or the YTC?

Response:

PMT $ 50.00

PV $1,092.00

FV $1,040.00

N 4

I 6.90%

The yield to call, because the interest rate is lower. The payments would be lower for the company issuing the bonds. However, people who are investing would prefer a higher rate of interest if the bond is priced the same. The reasoning behind this has also to do with the fact that the company is not doing well, and its future is uncertain. This would protect the company more against further loss.

Question 5

Explain the difference between interest rate risk and reinvestment rate risk. Which of the above bonds, A or B, has more interest rate risk? Which has more reinvestment rate risk?

Response:

Interest rate risk is the “risk of a decline in bond values due to rising interest rates (Ehrhardt, 2008).” Reinvestment rate risk is “the risk of an income decline due to a drop in interest rates (Ehrhardt, 2008).”

Bond B has more interest rate risk, and more reinvestment rate risk. It has 23 years left as well as a longer call provision remaining, thus it is exposed to greater risk on both accounts. This amount of time