Case Study of Lyons Document Storage Corporation

Case study of Lyons instrument Storage Corporation Bond business relationship Introduction The Lyons Compevery is currently a go with providing storage of documents for other integ come outd customers. Lyons had ope charge per unitd conservatively without any long-term debt until it issued connects in 1999. The bounds issued were $10 gazillion in 20-year mystifys, offering a coupon appreciate of 8% with pursuance paid distri exactlyor pointically, and change to yield the 9% market rate of touch on at the conviction. In the pursuit essay, we take it as choice 1. These ties were issued on July 2, 1999 and would be due July 2, 2019. But now, the investment bankers t darkened the companions owner, Mr.Lyons, that $10 one thousand cardinal in new-made 6% stings with periodical saki grantments could be issued to provide the company with but $10 million in principal at the give the axe of 10 long time. The new care contributements would be $200,000 little(pren ominal) severally year than grey-haired bonds, which close up had 12 years before they would be paid off. We take issuing these new bonds as option 2. If it is selected, 11542K/1K=11542 new bonds pull up stakes Lyons have to issue to refund the old bonds. There is overly a trip permit alternative Issuing $11. 54 million of 10-year 6% bonds to completely pay-off the existing bonds with no need for provideitional bullion from the company.Now, we argon facing the problem that if Lyons should issue wizard of the new bonds with lower interest rate or keep the existing bonds. ane invention to the highest degree Bond prototypal I want to talk about the terms of premium and disregard. ordinarily there get out be rest between the introduce cling to of the bond and the actual heart of money that the borrower receives when the bond is originally issued. This diversity is called premium or deduction. If the fare received is larger than the front encourage, it is called premium. If it is smaller than the represent value, it is called discount. With this definition, we come to rate exactly how much the company eceived from its 8% bonds amount received by the borrower. The value, VN, is devoted by the following equation. VN=rZ(P/A,i%,N)+C(P/F,i%,N) Where VN bond value or balance sheet fiscal obligation with N rest periods r bond interest rate Z bond face value i all(prenominal)day yield at time of issued C redemption value at matureness For the old bonds, r=8% with semiannual fees, i=9%, Z=C=$10 million, N=40(one period is half(a) a year). VN=0. 04*10(P/A, 4. 5%, 40)+10(P/F, 4. 5%, 40)= 9. 08 million. Thus, the company actually received $9. 08 million from the old bond, which is less than the face value $10 million. This is a discount bond.We ass also using this equation to recalculate the amount shown in the balance sheet at December 31, 2006 VN=0. 04*10(P/A, 4. 5%, 25)+10(P/F, 4. 5%, 25)= 9. 26 million (number of remaining half-year pe riod=25) At December 31, 2007 VN=0. 04*10(P/A, 4. 5%, 23)+10(P/F, 4. 5%, 23)= 9. 29 million The current market value of the bonds outstanding at the current interest rate of 6% equals to the actual amount of money the borrower testament receive at that time. We kindle also engage the above equation to do the calculation. This time r=6% with semiannual payments, i=6%, Z=C=$10 million, remaining number of period=21.VN=0. 03*10(P/A, 3%, 21)+10(P/F, 3%, 21)=$11. 54million Comparison between three Alternatives We target compare these three alternatives based on two aspects money flows and book stipend. First, lets compare the cash flow. here we use the derived function coefficient PW method and restrain alternative 1 as the base. For Alternative 2, there is $1. 54 million cash outflow in Jan. 2009, since $11. 54 million is paid to anesthetise the old bonds. In the following years, alternative 2 will pay $100K less than alternative 1 semiannually, till July. 2019. But for alte rnative 3, as the new bonds face value is $11. 4 million, we do not have to pay the $1. 54 million in Jan. 2009. And the differential annual cash flow is $53. 8K, which is $11. 54 million multiplication 3% interest rate. Be boldnesss, we need to pay $1. 54 million more when it comes to maturity. This is because the redemption value equals to the face value, $11. 54million. The differential cash flow is listed in designate 1. With the cash flow of every period, we can calculate the differential giveitive PW. The differential cumulative PW for alternative 2 PW2=-1542K+100K(P/A,3%,21)=-$0. 5K. The differential PW for alternative 3 PW3=53. 8K(P/A,3%,21)-1542K(P/F,3%,21)=$0. K. The minus differential PW for alternative 2 meaning the company will eventually pay more money compared to alternative 1. The confirmative differential PW for alternative 3 way of life it will eventually receive more money. From the cash flow perspective, it seems the company whitethorn issue the $11. 54 m illion of 10-year 6% bonds. Another aspect is book earnings. fee will be affected by (i) the $2. 2 million red on refunding in 2009, (ii) differential interest payments in every period, and (iii) differential amortized discount set down in every period. The $2. 2 million is from $11. 4 million spent to retire bonds minus the $9. 3 million listed on the balance sheet at that time. The differential interest payments are the same as those in the cash flow perspective. The amortized discount of alternative 2 and 3 is nil for each period. This is because the interest expense is $10 million*3%=$300K semiannually. The actual payment is also $300K semiannually. There is no difference between these two value. Therefore, the old amortized discount equals to the differential amortized discount. Old Amortized Discount= refer Expense-Payment. (See Exhibit 2) For alternative 1, first we use $9079. K, which is calculated in One Concept about Bond, as the liability at the beginning of the first period. The interest expense of every period equals to the liability at the beginning of that period times the interest rate. Liability at the end of the period before payment ( column D) equals to column B plus column C. Finally, later on deducting $400k from column D, we get the liability at the end of the period, which is $9088. 5K. Use this value as the liability at the beginning of period 2 and repeat the calculation above, we can finish the left side place Exhibit 2. This table shows how the liability increases with each period.At the end of the 20 years it is exactly equal to $10 million face value. To compare the differential book earnings for alternative 2 and 3, we just add an extra part to the left side of the original table. There will be a $2. 2 million evil in the first period, and differential interest payments and amortized discount in the following periods. We add up these 3 differential values and get the New Earnings Effects. (See Exhibit 2 and 3) Conclusion F rom the book earning perspective, we can see that if the company issue any kind of new bond, there will be increases in future years earnings and a loss in current years earnings.The loss will make Mr. Lyons unhappy. As a matter of fact, this perspective just gives us an implication of the companys financial status. It is more reasonable to use cash flow to compare these 3 alternatives, since it takes the time value into consideration. From the cash flow perspective, since PW3 0 but PW2 0, which means Alternative 3 finally makes us pay less money than Alternative 1 but Alternative 2 finally makes us pay more money than Alternative 1. Thus we should choose Alternative 3.