Question

1. CK Tech, a technology company, has had a 20% rate of growth for five consecutive years and has produced steady positive cash flows. The most recent economic and technology sector indicators show signs of slowing growth. CK Tech recently announced the issuance of bonds totaling 40% of the company’s current market cap. What would be a possible reason CK Tech has decided to raise capital this way? Explain why it is or is not an appropriate financing method for this organization?

Answer 1

Reason behind issue of bond is to increase the value of firm as interest payments on bonds provides tax shield. This increases the share price of the firm too. Value of firm after issue of bonds =Value of Equity+Debt*Tax Rate

It is not an appropriate way of raising capital as in future slow growth is pedicted. Moreover increase in debt or leverage increases risk in the firm . This might make the company more suseptible during downturn and might even reduce the stock price of the company