Debt financing benefits the stockholders. If equity is issued, the stock is diluted and stockholders lose some control and voting rights they currently have. They would also have to share any profits when the company issues dividends. RJR has already bought back more than 17 million shares of stock between 1984 to 1985, so it would be counterproductive to issue more stock at this time. Also, the company’s stock appears to be undervalued based on market to book valuation, therefore equity financing would not be beneficial at this time. Although the debt-equity ratio will increase for RJR with debt issuance, the benefits of issuing debt, far outweighs the negatives. The management team should act in the best interest of the stockholders.
Due to the fact that we had already issued debt instruments in the US market, we thought that the newly issued debt of $1 billion should be issued in a Foreign Market. While the Euro-market has the advantage of being less regulated, our plan to issue a dual currency Yen-dollar bond favors us issuing debt in the Japanese foreign market. Japan’s Ministry of finance has already started cracking down on Euro-market issued bonds that are brought back to Japan after issuance. They know that this is done to circumvent Japan’s new regulation which does not allow more than 10% of Japanese firm’s assets to be held in foreign securities. We do not want any investigation taking place with an issuance of this magnitude.
RJR should issue a Yen-dollar dual currency bond for various reasons. First, the all in cost of the Yen-dollar dual currency appear to be lower than the Eurodollar all in costs of 12%, when adding coupon and fees. Euro-yen bonds have an all-in fee of 8 & 1/4 % for coupons and fees. There would be an extra cost for the currency mismatch, as we would like hedge the currency risk of paying the coupons in Yen, but it should still be less costly. The hedging strategy would be achieved by creating a regular dollar liability. Since most of RJR and Nabisco’s income is based on US dollars, we need to assure that our liabilities are hedged to pay in dollars. Also, since we want an assurance of how much we are paying, the best hedging strategy would an FX forward. This would lock us into a fixed exchange rate, and our liabilities would not increase if the yen appreciates against the dollar. The redemption is set to be paid in dollars, so there is no need for hedging that payment. We realize that there’s a potential to have excess yen with a floating rate swap, according to Morgan Guaranty Ltd, but we do not want to speculate with the liabilities of this magnitude.
RJR’s next step after deciding to issue debt, is figuring out what is the proper maturity. We had to consider the fact that we have a commitment of $1.2 billion domestic twelve year note that is being issued. RJR also, recently issued $250 million in 30 year debentures, and $250 million in of eight year notes. Seeing as to how the $1.2 billion notes and the $250 million debentures are for 12 years and 30 years of maturity, we initially thought a 20 year maturity was appropriate for the additional $1 billion financing. However the Japanese market mostly consist of 5 to 10 year bonds, because they are used as an alternative the lower coupon paying Japanese bonds with maturities of mostly 10 years. Therefore we would like to issue Yen-dollar dual currency bonds of $500 million with a maturity of 5 years , and another $500 million with a maturity of 10 years.
by
kosiutek (student)
