You are an intern with Goodyear Tire & Rubber Co in their corporate finance division. The firm
Question:
You are an intern with Goodyear Tire & Rubber Co in their corporate finance division. The firm is planning to issue $200,000,000 of 6.00% senior notes with a 10-year maturity.
Each note will bear interest at a rate of 6.00% per annum and the firm will pay interest annually to holders of record at the close of business on the 15 days immediately preceding the interest payment date. Interest will be computed on the basis of a 360-day year comprised of twelve 30-day months.
The firm anticipates an increase in its bond rating. Your boss wants you to determine the gain in the proceeds of the new issue if the issue is rated above the firm’s current bond rating. To prepare this information, you will have to determine Goodyear’s current debt rating and the yield curve for their particular rating.
1. BeginbyfindingthecurrentU.S.Treasuryyieldcurve.AttheTreasuryWebsite www.treas.gov select “Data” and click on “Daily Treasury Yield Curve Rates”. View and download that table into Excel. You could use other Web sites as well.
2. Findthecurrentyieldspreadsforthevariousbondratings.Unfortunately, the current spreads are available only for a fee, so you could use data from Moody’s report: Market Data Highlights. First, go to www.moodys.com and register for free at Moody’s, use search at Moody’s Webpage: “Market Data Highlight”. Download the last “Cross-Sector: Market Data Highlight” report and adopt Global Corporate Median Credit Spreads (Figure 11). Download this table to Excel, extrapolate missed spreads, and copy and paste it to the same file as the Treasury yields.
3. FindthecurrentbondratingforGoodyear.GotoStandard&Poor’sWebsite www.standardandpoors.com, select “Find a Rating” from the list at the left of the page, then click “Find”. At this point, you will have to register (it’s free). Next, you will be able to search by Organization Name—enter Goodyear and select. Use the credit rating for the organization, not the specific issue ratings. Alternatively, use Bloomberg terminal or go to FINRA Web site:
https://finra-markets.morningstar.com/MarketData/CompanyInfo/default.jsp.
4. Return to Excel and create a timeline with the cash flows and discount rates you will need to value the new bond issue.
a) To create the required spot rates for Goodyear’s issue, add the appropriate spread to the Treasury yield of the same maturity.
b) The yield curve and spread rates you have found do not cover every year that you will need for the new bonds. Specifically, you do not have yields or spreads for four-, six-, eight-, and nine-year maturities. Fill these in by linearly interpolating the given yields and spreads. For example, the four-year spot rate and spread will be the average of the three- and five-year rates. The six-year rate and spread will be the average of the five- and seven-year rates. For years 8 and 9 you will have to spread the difference between years 7 and 10 across the two years.
c) To compute the spot rates for Goodyear’s current debt rating, add the yield spread to the Treasury rate for each maturity. However, note that the spread is in basis points, which are 1/100th of a percentage point.
d) Compute the cash flows that would be paid to bondholders each year and add them to the timeline.
Use the spot rates to calculate the present value of each cash flow paid to the bondholders.
Compute the issue price of the note and its initial yield to maturity.
Repeatsteps4–6 based on the assumption that Good year is able to raise its bond rating by one level. Compute the new yield based on the higher rating and the new note price that would result.
Compute the additional cash proceeds that could be raised from the issue if the rating was improved.
Assume each note will bear interest at a rate of 6.00% per annum however Goodyear will pay interest semiannually (at the rate of the coupon in two payments per year). How does it influence note price and its yield to maturity?