Debt Issue Harvard Case Solution & Analysis

RECOMMENDED DEBT SECURITY FOR JAMES HARDIE

INDUSTRIES LTD

James Hardie is looking to raise $500m debt. It could raise this debt either in the Australian market or the US market. The company is also registered on the Australian securities exchange. The financial statements of James Hardie show a debt of US$13. 8m till 31st March 2014. Compared to this the $500m debt value is quite huge. Therefore the company needs to decide for a suitable debt security option to raise the necessary funds.

A corporate bond is one of the debt securities which corporations issue to raise the required funds. The company pays interest (coupon payment) on these bonds to the bond holders. The bonds could be issued through a medium such as an exchange. The price of the bond is determined with respect to the prevailing interest rates and the credit rating of the company. The company could charge a coupon rate above or below the market rate, also known as yield to maturity. If the company charges coupon rate above the market rate then it would issue bonds at a premium price. If the company pays a coupon less than that market rate, then the company will issue the bonds at a discount. However, if the coupon rate is equal to the market rate then the bonds would be issued at par. Apart from that the company could issue deep discount bonds on which the company does not have to pay any coupon payments.

The recommended security that James Hardie could issue to raise the $500m debt would be to issue corporate bonds in the market. The company should issue corporate bonds with a maturity of 20 years. The coupon rate of 10% would be an appropriate rate for the company. The bonds should be issued in the Australian market. The coupon rate is normally decided by the interest rate on the similar type of securities with a similar level of risk and maturity. Also the company could ask its potential purchasers that what rate of coupon they may be willing to pay to the company. The company needs to decide to whether to issue the bond at premium or discount. Since James Hardie is going to issue the bonds for the first time, as the financial statements reveal, it should issue the bonds at par so that the coupon rate will be similar to the market rate of return. The bond holders should be obligated to make annual payments of the bond. The bonds should be issued at a face value of $100,000.

The company can also reduce its risks associated with either the default on the payment of interest on the repayment of principle. Also, if the company performance starts to deteriorate there are certain embedded options that could save the company from the risks associated with the bonds. These embedded options are basically the additional rights or provisions given along the debt or equity security to perform some actions related to the debt, to be performed in the future. These embedded options give either the issuer of the debt or the bondholders to give them certain rights. The rights associated with the bondholders could be like the investors might have the right to sell (put) the issue of the bonds or if there is a floating-rate they can put a floor to it. Such options available to the issuers could be that the entity might have the right to buy (call) the issue of the bonds or if there is a floating rate it could set a cap on it. James Hardie could also make use of such options to reduce the future risks. However, if such embedded options are included along with the bond the value of the bonds is decreased. For example, if a company is issuing bonds to the general public and it includes an embedded option like for instance, these bonds are callable bonds. Therefore, now these bonds will value less to the bondholders because the issuer of the bonds could call back the bonds any time they want which will deprive the investors from the future interest rate payments which they were about to receive in future. Therefore, the company has to set a fair price of such bonds if it has to include such embedded options along with the issue of the bonds.

James Hardie should use such as embedded option. They should include the option of callable bonds. As the company is now going to issue the bonds at par, it will have to make annual coupon payments for 20 years till the maturity of the bonds. This is a long time horizon, there situation might worsen and the company might not pay back its annual coupon payments..................................

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