Bay Path Cranberry Products

Bay Path Cranberry Products is a leading producer of cranberry juice, canned cranberry sauce, fresh berries, and sweetened dried cranberries, with production and processing facilities in Massachusetts and Wisconsin.  Sales of traditional products such as fresh berries and canned cranberry sauce have been declining for a long time; the fastest-growing products have been juices and dried fruit, especially "light" and sugar-free juices.  Industry-sponsored advertising has highlighted research showing that cranberries are rich in antioxidants and other phytonutrients that may protect against heart disease, cancer, stomach ulcers, gum and urinary tract infections, and even such age-related afflictions as loss of coordination and memory.

These trends confirm the marketing department's belief that Bay Path should aggressively pursue the same health-conscious consumers who purchase certified organic products.  Despite the growing popularity of organic food products and the demonstrated willingness of affluent consumers to pay a premium price for them, the cranberry industry has been slow to enter the field.  Bay Path executives have now decided to introduce an organic line of products, starting with juice and blended juice.  This new line will become their highest strategic priority for the next two years.

The introduction of certified organic products will be expensive.  Preliminary estimates indicate that Bay Path will need to invest $80 million in production and processing facilities.  The company hopes to finance the expansion by using $30 million of its own liquid assets and $50 million in new debt in the form of bonds with a maturity of 20 years.  Bay Path expects the bonds to receive a rating of Aa1 or better from Moody's.

Required:

For all questions, assume par value is $1,000 and semiannual bond interest payment.

1. A company in a line of business similar to Bay Path's recently issued at par noncallable bonds with a coupon rate of 5.8% and a maturity of 20 years.  Moody's rated the bonds Aa1 and Standard & Poor awarded them AA.  What rate of return (yield to maturity) did investors require on these bonds if the bonds sold at par value?

2. Bay Path has one outstanding bond issue with a coupon of 8% that will mature in five years.  The bonds now sell for $1,141.69.  What is the yield to maturity on these bonds?

3. Based on your answers to Questions 1 and 2, what coupon rate should Bay Path offer if it wants to realize $50 million from the bond issue and sell the bonds as close to par value as possible?

4. Suppose Bay Path actually offers a coupon rate of 6% on its twenty-year bonds, expecting to sell the bonds at par.  What will happen to the price of a single bond with a par value of $1,000 if the required bond yield unexpectedly falls to 5% or rises to 7%?

5. How much money will Bay Path realize from its $50 million bond issue if the actual yield is either 5% or 7%?

6. How would the following affect the yield on Bay Path's newly issued bonds?

a. The bonds are callable.

b. The bonds are subordinated to Bay Path's existing bond issue.

c. The bond rating is better or worse than the Moody's Aa1 that Bay Path anticipates.