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Learning Objectives

Learn about key features of long-term debt, bond yield differences, and analyzing refunding decisions in finance. Explore examples and strategies in determining whether to call in and reissue debt.

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Learning Objectives

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  1. Learning Objectives • Identify and describe the key features of long-term debt. (LO1) • Differentiate bond yields and prices as influenced by how corporations and governments are rated by bond rating services. (LO2) • Analyze the decision of whether or not to call in and reissue debt (refund the obligation) when interest rates have declined. (LO3)

  2. LO3 The Refunding Decision • When market interest rates decline, selling new low coupon rate bonds to buy back the existing high coupon rate bonds is called a refundingoperation. • To refund a bond, the bond indenture agreement should include a call provision. • The refunding decision is analyzed as a capital budgeting problem. • The goal is to see whether savings in interest costs exceed financing costs related to redeeming and reissuing bonds.

  3. LO3 A Refunding Decision Example:

  4. LO3 The refunding decision:Step C—Net Present Value Costs (Outflows) Benefits (Inflows) 1. Net cost of call 4. Cost savings in lower premium . . . ($1,000,000) interest rates $2,150,610 2. Net cost of borrowing expenses on new issue (181,558) 3. Duplicate interest during overlap period . . . (43,750) Present value of costs ($1,225,308) Present value of benefits $2,150,610 Net present value . . . . $ 925,302

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