Case – Office Products, INC.
Office Products, Inc. (OPI) is a leading manufacturer of prescription and ethical drugs; specialty foods
and candies; and proprietary drugs. Important product names include Advil, Anacin, Dimetapp,
Norplant, and Robitussin. Total revenues in the last fiscal year were in excess of $8 billion. The current
corporate income tax rate is 20%. The company has a capital structure that is made up of 30 percent
long-term debt, 5 percent preferred stock, and 65 percent common stock.
Long-Term Debt
One of the two largest domestic long-term debt issues is a 10% coupon bond. This debenture is
currently selling for $920. The bond is callable in seven years and it will be redeemed at a premium of
120. The other large publicly held bond is a 12% coupon bond that is due in 08 years. This debenture
is selling for $950. Both of these bonds have $1,000 face value.
Preferred Stock
The preferred stock is a stated value of $40, but it is currently selling for $45. More than 6.5 million
shares were issued in February 2015 in connection with the merger of FDS Holding Company into a
subsidiary of OPI. The preferred stock has no voting rights, and entitled 15% dividend.
Common Stock
Returns from common stock come from the cash dividend payment and/or changes in the price of the
stock. Investors receiving dividends can expect them to grow over time, but some stocks do not pay
dividends, especially during their early growth years. As firms mature, they typically start paying
dividends and then management is very reluctant to reduce the dividend. For the firms that do not
pay dividends, the normal assumption is that the earnings are being retained by the firm to promote
growth; thus, the stock price should grow at a higher rate than firms that have high payout ratios.
Two major factors that affect the price of stock are changes in the required rate of return, caused
primarily by changes in the risk, and change in the growth rate of earnings, which in turn create
changes in the growth rate of dividends.
The common stock of Office Products currently has over 100 million shares of $20 par value stock
outstanding. A share of common stock presently sells for $52 and currently no paid dividend. It is expected to pay a dividend of $3.50 per share after 02 years and after that the dividend will continue
to grow at an annual rate of 5%. The common shares have no preemptive rights. Stockholders of OPI
have the opportunity to buy additional shares of common stock through a plan of automatic dividend
reinvestment and optional cash purchase.
Answer the following questions,
1) Look at the 10% and 12% coupon bonds. What is its current yield of both bonds?
2) The Financial Manager has received a proposal to increase the long-term debt in the
capital structure. What is your opinion on this proposal?
3) Calculate the expected return on the company's bonds separately.
4) What would be the value of the 10% and 12% coupon bond? Is the purchase of these
bonds advantageous to the investor?
5) What is the required rate of return for the preferred stock? How does this rate compare
to the YTM for the OPI 10% bond? Is this difference what you would have expected from
a risk/return standpoint?
6) Calculate the value of a preferred share.
7) Assuming that the OPI common stocks are sold at Rs 60 each after 02 years, what is the
capital gain yield?
8) Assume that the risk-free rate is 6 % and that the expected return of the market is 11%.
According to the security market line (SML) valuation model, what is the required rate of
return for OPI common stock if its beta is 1.20?
9) What is the practicality of taking into account cash flow after tax when calculating the
cost of bonds?
10) Calculate the weighted average cost of capital (WACC) based on the current capital
structure of the company and explain the importance of the weighted average cost of
capital to the company. (Assume that 10% and 12% bonds contribute equal amounts to
the capital structure.) (5 x 10 Marks)