Mogen Case Study

1. It is important for MoGen to get $5 billion of external funding in 2006. There are four areas that need a total funding of $10 billion, MoGen expected internally generated sources of funds of $5 billion, and thus, it needs further $5 billion of external funding.

The four areas that need funding are:

• $1 billion for expanding manufacturing and formulation, and fill and finish capacity in order to meet the increase in demand and remove supply risk;
• $3.5 billion for expanding investment in R&D and late-stage trials in order to maintain momentum behind its new drug development pipeline and diversify its product line;
• $2 billion for acquisition and licensing in order to achieve a strong growth in revenues and earnings per share;
• $3.5 billion for the stock repurchase programme in order to return cash to shareholders, as the company has never issued dividends to shareholders.

 MoGen preferred the flexibility of repurchasing shares to paying dividends. Because due to the highly uncertain nature of its operations, if MoGen goes for paying dividends instead repurchasing shares, there is always the risk of decreasing the dividend during hard time which, when announced, will likely result in a significant drop of the stock price. In addition repurchasing shares has a favourable impact upon EPS by reducing the shares outstanding.

1. Pros and cons of convertible bonds:

From the issuer point of view:

• It allows the issuer to pay a lower coupon rate as a result of giving the investors the option to convert the bond into equity at a fixed price;
• It allows the issuer to get use of tax shield before practicing the conversion option;
• It allows the issuer to sell common stock indirectly at a price higher than the current price;
• It allows the issuer to delay the dilution of ownership, voting and EPS;
• On the other hand, it runs the risk of diluting not only the EPS of the company's common stock, but also the control of the company. If a large part of the issue is purchased by one buyer, conversion may shift the voting control of the company away from its original owners and toward the converters.

From the investor point of view:

• It offers the investor the safety of bond, which comes from the bond’s coupon payments;
• It offers the investor the upside potential of equity, which comes from the ability to convert the bond into shares of common stock;
• On the other hand, the investor should be aware that some financially weak companies will issue convertibles just to reduce their costs of financing, with no intention of the issue ever being converted.

1. The Black-Scholes pricing formula for call options:

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• Strike price = $77.98 * (1+25%) = $97.48
• Stock price = $77.98
• Time = 5 years
• Volatility (%) = 27.0%
• Risk free interest rate (%) = 4.65% Treasury bond (20-year)

Using these variable in Black-Scholes pricing formula gives a call option price of $18.79.

Conversion ratio = bond face value / strike price = $1000 / $97.48 = 10.26

1. a. The value of straight bond component = straight bond – call option value

• Straight bond = face value + present value of coupon payments (where n=10, I=2.875%, PMT= 28.75, PV = ?) = 1000 + 246.82 = 1246.82
• Call option value = 18.79 * 10.26 = 192.79

Thus, the value of straight bond component = 1246.82 – 192.79 = 1054.03

b. The coupon rate that Manaavi should propose in order for the convert to sell exactly $1000 per bond = 1.26% (where n=10, I=2.875%, PV= 54.03, PMT=?).

c. The discount rate used to value the straight bond component is 5.75% as MoGen is able to issue straight five-year bonds with that yield.