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Mandatorily Redeemable Fixed-Term Fixed-Rate Debentures

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Alternative 3: mandatorily redeemable fixed-term fixed-rate debentures

On 1 January 20x0 BuildItYourself receives L$20 million in exchange for 1 million L$20 ten-year debentures that, collectively, contractually oblige BuildItYourself to pay:  L$1 million (ie 5 per cent fixed interest) on 31 December each year for 10 consecutive years; and a final payment of L$20 million (ie L$20 for each debenture) in full and final settlement of the obligation to the debenture holders (ie fixed redemption at par) on 31 December 20x9

  • Financial liability: obliged to pay & fixed amount

Alternative 6: mandatorily redeemable fixed term preference shares—with fixed dividends but without voting rights.

On 1 January 20x0 BuildItYourself receives L$20 million in exchange for issuing preference shares that have no voting rights and have the contractual obligation to pay:  L$1.15 million (ie 5.75 per cent per year fixed non-discretionary dividend) on 31 December each year for 10 consecutive years; and  a final payment of L$20 million in full and final settlement of the obligation to the preference-shareholders (ie fixed redemption at par) on 31 December 20x9. On liquidation only the ordinary shareholders’ claims are more subordinate than the claims of the non-voting preference shares against BuildItYourself’s net assets.

  • Financial liability: contractual obligation, fixed dividends

Alternative 8: convertible debentures—exercisable during the 6 years before maturity

The facts are the same as Alternative 3 except, in this case (Alternative 8), interest payments are L$600,000 (ie 3 per cent) per year and the debenture holders may any time after 1 January 20x4 but before maturity, at their sole discretion require BuildItYourself to convert each debenture held into one BuildItYourself ordinary share. Any debentures not converted into ordinary shares by 31 December 20x9 must be redeemed at their face value (ie L$20).

  • Financial equity?

Alternative 9: mandatorily redeemable debentures with conditional early redemption feature

The facts are the same as Alternative 3 except, in this case (Alternative 9), interest payments are L$1.1 million (ie 5.5 per cent per year) per year and BuildItYourself may any time after 1 January 20x7 but before maturity, at its sole discretion, redeem all of the outstanding debentures at par (L$20) plus interest accrued since the last interest payment date, provided that (ie conditional upon) the market price of BuildItYourself ordinary shares exceeds L$26 for longer than seven consecutive working days immediately before the election is made.

  • Financial equity?

In alternative 3 BuildltYourself issue a fixed-term, fixed rate debenture for 10 years at 5% interest. This will obligate BuildltYourself to pay 5% interest for 10 years at contractual basis. The risk will be that the interest rate will fall in the market, what results in to expensive debt issue, so the opportunity cost will arise. There is also a risk that the market conditions will be less good then expected. The projected cash flow will drop and the business will be getting trouble to pay 1 million of interest payments.

In alternative 6 BuildltYourself will issue preference shares to get the LS20 million. They will be obligated to pay 5,75% dividends.  Preference shares have prior claims on the company’s assets in case of liquidation. In case the dividend requirements can’t be met, the preference shareholders have the right to receive the dividends payments before common shareholders get dividends. Further it’s important to now that bondholders don’t have the same guarantees, the required interest is be higher, what means that the yield and so on the cost of capital will be higher for BuildltYourself.

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