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LONG TERM

FINANCING DEBT
AND
ChaptersEQUITY
15, 20

Long Term
Financing An
Introduct
ion

Long Term Financing - Debt and


Equity

Chapters 15, 20 and 21

An Introduction - Outline
3

Internal and external financing in


Canada
Common stock.
Features, shareholder rights, share
classes.

Long term debt.


Preferred shares.

Long Term Financing - Debt and


Equity

Chapters 15, 20 and 21

Financing New
Projects - Pecking
Order
Theory
Firms prefer
to fnance with internally

generated cash fow rather than outside


sources of funds.

Canadian firms have historically financed


about 2/3rds of their investment needs from
internally generated cash flow.
Firms adapt dividend policies to reflect their
long term financing needs but because of
fluctuations in a firms cash flow, retained
earnings might not be enough.

If a frm has excess cash, it will tend to


pay of debt
repurchasing
shares.
Longbefore
Term Financing
- Debt and
Chapters
15, 20 and 21
Equity

Internal and External


Financing for Canadian Firms,
250,00
1991-2009
0
interna
l
fnanci
Trust
ng
units

200,00
0
150,00
0
100,00
0
50,00
0
50,00
0

199
1

199
4

199
7

200
0

200
3

Long Term Financing - Debt and


Equity

200
6

200
9

Comm
on
stocks
Preferre
d
stocks
Corpora
te bonds

Chapters 15, 20 and 21

Stock Performance Following


Debt Issues
Impact of Securities Offerings and Bank Borrowing on
the Value of the Firms Common
Stock
2-Day Abnormal Stock
Return
Smith
James
L&M
Convertible preferred stock

-1.44%

Preferred stock

-0.19%

Convertible bonds

-2.07%

Public straight bonds

-0.26%

Private placement of debt


Bank loan agreement
New bank credit agreement
Long Term Financing - Debt and
Revised bank agreement

0.11%
0.91%
1.93%

0.61%

0.01%
Chapters 15, 20 and 21
3.98%

Common Shareholders
7

Common shareholders are frm owners and residual


claimants.
Common shareholders face limited liability.
Shareholder rights:

Right to share proportionally in dividends paid or in


assets after all liabilities are paid.
In theory, have control over operations of company (e.g.
the right to vote at annual meetings).
Right to share proportionally in any new stock sold when
approved by a board of directors.
Right of transfer.

Straight voting is one vote per share


Cumulative voting is # votes = # shares held x #
directors to be voted.

Term Financing
- Debt and
Provides for Long
minority
participation.
Equity

Chapters 15, 20 and 21

Features of Common Stock


8

Authorized versus outstanding shares.


Contributed surplus versus retained
earnings.
Shares may have diferent classes of
common stock:

Diferent voting rights for insiders and


outsiders.
Diferent voting rights for foreigners.

Dividends

Corporations cannot default on undeclared


dividends.
Dividends are not seen as a business
Term Financing - Debt and
Chapters 15, 20 and 21
expense Long
not
tax
deductible
to
firm.
Equity

Ethical Issues with Dual Class


Voting Rights

Dual class voting rights separate cash


fow rights from voting rights among
diferent groups of shareholders:

Allow tightly held firm to raise financing


without diluting control.
Deter corporate raiders from gaining
control of a firm.

Dividends on nonvoting stock must be at


least as high as dividends on voting stock.
BUT
If insiders hold shares with better voting
Term Financing - Debt and
Chapters 15, 20 and 21
rights, theyLong
have
the
incentive
to
Equity

All Sorts of Values


10

Book Value

Market Value

Sum of retained earnings, contributed surplus, and


share capital (initial proceeds from issue of equity).
Measure of what has happened in the past.
Current market price of the equity.
A measure of future prospects of the frm.

Market-to-Book ratio

The ratio of market-to-book is a measure of fnancial


success of the frm.
If this is greater than 1 frm is growing, has good
prospects for the future.
If ratio <1, either frm is undervalued, or there is
something fundamentally wrong with company.
Long Term Financing - Debt and
Equity

Chapters 15, 20 and 21

Straight Debt Distinctions


11

Debt is not ownership in the frm:

No voting power.
Interest payments on debt are fully tax
deductible by corporation.
Unpaid debt is liability of a frm.

Long Term Financing - Debt and


Equity

Chapters 15, 20 and 21

Preferred Shares
12

Senior to common stock, junior to debt.


Shares have a stated liquidating value
on the and typically have a stated
divided per share amount.
Most have cumulative dividends if the
frm misses paying a preferred share
dividend.
If dividends have been deferred:

Common shareholders must also forego


dividends.
Long Term Financing - Debt and
Chapters 15, 20 and 21
Preferred Equity
shareholders may be granted

Preferred Shares
13

Convertible preferred shares.

Can be exchanged for common shares in


the future.

Adjustable rate dividends - usually


tied to prime rate.
Preferred shares often have ratings
just like bonds.
Some issues have associated sinking
funds:

This implies that issue will be ultimately


Term Financing - Debt and
Chapters 15, 20 and 21
retired. Long
Equity

More on Preferred Shares


14

From investors point of view From firms point of view

Preferred shares
Canadian
increase leverage
corporations do
marginally.
not pay tax on
They do not dilute
preferred share
control of company.
dividends received
Non payment of
from other
dividends does not push
Canadian
the company into
corporations.
bankruptcy.
Individuals do pay
Expensive, unless they
tax.
are lightly taxed or dont
pay tax at all.
Most preferred
Term Financing - Debt and
Chapters 15, 20 and 21

shares are Long


Yield rates are
Equity

A Summary of Financing
Instruments
Common Stock

Preferred Stock

Bonds

Ownership

Voting rights.

Generally no

Obligation to
provide return

None

Bankruptcy
Claims
Distn Cost
Risk return
trade off

Lowest

Before
common
dividends
Second

Limited rights
under default
Contractual
Obligation

Tax status of
payment by firm
Tax status of
payment to
holder
Tax status
Chapters
15, 20 of
and 21
payment to

Highest
Highest risk;
highest return

Moderate
Moderate
risk;
moderate
return
None dividends
None dividends
pd from after tax
pd from after tax
income.
income.
Grossed up
Grossed up
dividend tax
dividend tax
credit
credit
Tax exempt
Tax exempt
Long Term Financing
- Debt and
Equity

Highest
Lowest
Lowest risk; lowest
return
Interest payment
is tax deductible
Fully taxable
Fully taxable
15

16

Issuing Equity
Securities

Long Term Financing - Debt and


Equity

Chapters 15, 20 and 21

Issuing Equity - Outline


17

The basic procedure:

Public and private oferings.

New equity sales and the value of


the frm.
IPOs.
Features of common stock.

Long Term Financing - Debt and


Equity

Chapters 15, 20 and 21

How Firms Raise Equity


18

Publicly via a general cash ofering


made to all investors

Public pays cash for shares.


Cash sales facilitated by an underwriter.

Privately via private placement, or


with venture capital.

Long Term Financing - Debt and


Equity

Chapters 15, 20 and 21

Procedure for a New Issue


19

Management obtains approval from board of


directors to issue securities.

Prepare prospectus for securities commission and


potential investors.

Once registration is fled, there is a 20 waiting period for


approval.

After approval, issue is priced seasoned oferings


are priced close to current market value.

They obtain an underwriter, decide how much money is


to be raised and what sort of securities should be issued.
This could take several months.

A full prospectus is developed. Because the price is set


as close to the current market price, frms want a very
short window between when the security is priced and
when it is ofered for sale.

Securities

Long Term Financing - Debt and


areEquity
ofered for sale

Chapters 15, 20 and 21

the underwriter

20

Regulation of Public Sources of


Capital

Public securities governed by SEC in the


States and in Canada, each province has
regulatory body.
Firms that list on the TSX come under the
jurisdiction of the Ontario Securities
Commission.
There is a move towards more uniform
regulation across Canada as proposed by
the Canadian Securities Administrators.
Regulators are responsible not only the
listing of securities,
but also the
gathering
Long Term Financing - Debt and
Chapters 15, 20 and 21
Equity
and publishing
insider reports, overseeing

21

Decreasing Regulatory
Drag
Prompt Ofering Prospectus System

Large, existing firms that make regular


disclosures to OSC (and other provincial
regulators) are waived from prospectus
requirement.
Use short-form prospectus.
Takes 5 days to be reviewed instead of 20
days.
Popular with bought deals.

In early 1990s US and Canada


introduced Multi- Jurisdictional
Disclosure Long
System
Term Financing - Debt and
Chapters 15, 20 and 21

Equity
Way for firms
that trade in Canada and US

22

Role of Underwriters in
General Cash Ofering

Underwriters have four main functions:

Origination - the mechanics of producing the


issue, including pricing advice.
Distribution - selling the issue.
Risk bearing - issuing new shares is risky! The
amount of risk borne depends on the
underwriting agreement.
Certification - quality control.

Compensation received is called the


spread or the diference between the
underwriter's buying price and the selling
price.

Amount of compensation is a function of the


Term Financing - Debt and
Chapters 15, 20 and 21
amount ofLong
risk
borne
by
underwriters.
Equity

23

Types of Underwriting
Agreements

Firm Commitment

Best Efforts

Underwriter buys entire issue at a fixed


price and then resells it. Underwriter bears
risk of under-subscription.
No commitment to sell all securities.
Securities sold on a fixed commission basis.
Firm bears undersubscription risk.

Bought deal

Canadian invention. Underwriter buys entire


issue before initial prospectus is produced
Long investors.
Term Financing - Debt and
Chapters 15, 20 and 21
and lines up
Equity

24

The Cost of Issuing


Securities
Spread:
Abnormal returns:

Other direct
expenses:

The diference
between the price
the issuer receives
and the ofer price.

These are costs


incurred by the
issuer, that are not
part of the
compensation to
underwriters.

Indirect expenses:

Underpricing:

Price drop in trading


stock upon
announcement of
seasoned issue.
Arises in IPOs.
Loss that arises from
selling shares for less
than they are worth.

Overallotment
(Green Shoe)
option:

These costs are not


reported onLong
the
Term Financing - Debt and
prospectus.Equity

Covers excess
demand for issue.
Chapters 15, 20 and 21

The Cost of Going Public in


Canada, 1984-1997 (table
20.6)
Fees
6.00%
Underpricing (first day trading 7.88%
return)
Total
13.88%

The above fgures understate the total


cost because they ignore indirect
expenses or the overallotment option.
In the U.S.: IPOs have an average cost
of 10.14%. (1990 to 2008)

Chapters 15, 20 and 21

Long Term Financing - Debt and


Equity

26

Why Do Stock Prices Drop


When Firm Issues New Equity?

When firms raise funds through a seasoned


ofering, current stock price falls 2% - 3%.
Information Asymmetry:

Revised Beliefs about Financial Distress

Firm is issuing stock now because common stock is


over valued.
Firms have the incentive to issue equity if they
are facing future fnancial distress.
Thus the market interprets an issue of equity as
a sign that the frm must be facing higher
fnancial distress costs.

Signal of Bad News:

Term Financing
- Debt
Chaptersissued
15, 20 and 21
If frm had Long
good
news,
it and
would have
Equity

The Initial Public Ofering


27

First ofering of stock to general


public.
Similar to ofering a seasoned equity
ofering, except for the price setting.
Steps involve:

Firm contracts underwriter to bring IPO


to market.
Prospectus is produced.
Stock price is set (typically way before
expected market price).
Long Term Financing - Debt and
Chapters 15, 20 and 21
Issue is listed.
Equity

Performance of IPOs
28

Look at the diference between the


ofering price and the price shortly
after ofering 10 20% underpricing.
(see table 20.3 in text).
Why under-price?

Underwriter incentives.
Leave investors with a good taste in
their mouths.
Signalling (Grinblatt and Hwang (1989)).
Asymmetrically informed investors (Rock
Chapters 15, 20 and 21
(1986)). Long Term Financing - Debt and
Equity

29

When Some Investors Have


Better Information: the
Firms A and B are
going public and each have 50
Winners
Curse

shares for sale.


Over subscribed issues will be allocated on a
proportional
basis.
Firm
Low
Probability
High
Probability
The following frm value expectations are common
Firm
of Low
Firm
of High
knowledge.
Value
Value
Value
Value
A
5
0.5
15
0.5
B
5
0.5
15
0.5
You have $100 to spend on shares.
Suppose the underwriter prices both A and B at
$10 per share. What would you do?
Some of you will have private information...
Long Term Financing - Debt and
Equity

Chapters 15, 20 and 21

The Winners Curse Finale


Group #
Shares
A
Request
ed
1
2
3
4
5
6
7
8
9
Chapters
10 15, 20 and 21

#
Shares
A
Receive
d

#
Shares
B
Reques
ted

Long Term Financing - Debt and


Equity

#
Shares
B
Receive
d

31

Three Empirical Conclusions


on Underwriting Costs

There are substantial economies of


scale in issuing securities.
For smaller issues, the cost of
underpricing may exceed direct
issue costs.
It costs more to foat an IPO than a
seasoned ofering.

Long Term Financing - Debt and


Equity

Chapters 15, 20 and 21

32

Pricing a New Issue


(Simplifed)

First step is to calculate value of frm for


IPO:

Use dividend growth model, estimating


rs the total dividends to be paid and
the expected dividend growth rate.

Value of all equity firm

payable next year


S

Total cash dividends

rs

net
P

E
income

estimated
dividend
growth
Then priceLong
per
share
is S/rate
# shares
Term Financing - Debt and
Chapters 15, 20 and 21

issued.

Equity

Example
33

Thomas Enterprises is planning its frst


public ofering of common stock. The CFO
estimates that the equity investors
required rate of interest is between 13%
and 15%. Earnings and cash dividends are
expected to grow by 7% - 8% a year for the
foreseeable future, while cash dividends to
be paid out next year total
$500,000.

What is the range of possible total current


market values for the stock of this firm?
There are Long
million
shares of stock
Term Financing - Debt and
Chapters 15, 20 and 21
Equitybut 100,000 will be held by
outstanding,

34

Long Term
Debt

Long Term Financing - Debt and


Equity

Chapters 15, 20 and 21

35

Liability Management Outline

Corporate bond features, covenants


and options
Callable bonds.
Diferent types of bonds.

Zero coupon and floating rate bonds.

Bond refunding.
Bond ratings.

Long Term Financing - Debt and


Equity

Chapters 15, 20 and 21

Corporate Bond Features


36

A bond is simply long term debt. The


interest paid on the bond is called the
coupon and the amount that is paid on
maturity is the face value of the bond.
Features of a bond include:

Cash flow pattern (coupon, amortisation &


face value).
Price.
Bond covenants.
Maturity.
Options.
Long Term Financing - Debt and
Chapters 15, 20 and 21
Equity
Bond rating.

Features of a Hypothetical
Bond

Terms

Explanation

Amt of
Issue
Issue Date

$100
million
10/21/10

Maturity

10/21/30

Annu
al
Coup
on
Ofer Price

10.5

100

Chapters 15, 20 and 21

Yield

10.5

The company will issue $100m in


bonds
The bonds will be sold on Oct. 21st,
2010
These are 20 year bonds: the
principal will be paid back on
October 21st 2030.
The denomination of the bonds is
$1000. Each bondholder will receive
$105 in interest a year.
The ofer price will be 100% of the
face value, so it will be sold at
$1000.
Long Term Financing - Debt and
EquityIf the bond is held to maturity,

Features of a Hypothetical
Bond

Terms

Explanation

Coupon
12/31, 6/30
Paymt
Dates
Security
None
Sinking Fund Annual

Coupons are paid out semi


annually. Each coupon is for
$105/2 =$52.50.
The bonds are debentures
The frm will make annual
payments into a sinking fund to
accumulate the principal
Firm can repay bondholders at
any date after Oct 21st, 2020.

Call Provision Not


callable
before
10/21/20
Call Price
$1100
Chapters 15, 20 and 21

Rating

AAA

If bonds are called early, frm


will pay bondholders $1100
per bond.
Long Term Financing - Debt and
Equity DBRS highest rating.

Rating Symbols
39

Dominion bond rating service


Investment Grade - High Creditworthiness

AAA highest investment quality..


AA superior investment quality. Very little diference
between AA and AAA.
A upper medium grade securities.
BBB- medium grade securities. Protection of interest and
principal is considered adequate.

Junk Bonds Lower Grade and Speculative

BB lower medium grade.

B middle speculative. Uncertainty exists as to whether


frm can make future interest and principal payments
CCC in danger of default.
CC are in default of either interest or principal
C lowest rated bonds.

Long Term Financing - Debt and


Equity

Chapters 15, 20 and 21

Indenture Agreement
40

Formal agreement (contract).

It can be several hundreds of pages long!

To protect debtholders, contract details


covenants or restrictions on the issuer
of the debt.
Contract may also list options actions
which may be available to either the
borrower or the debt holder in the
future.
Long Term Financing - Debt and
Equity

Chapters 15, 20 and 21

Bond Covenants
41

Covenants can an be either positive


(what the frm must do) or negative
(what the frm cant do).

Dividend covenants.
Financing covenants (how a firm can
raise debt in the future)
Financial ratio covenants.
Sinking fund covenants.
Bonding covenants.
Long Term Financing - Debt and
Equity

Chapters 15, 20 and 21

Financing Covenants
42

Seniority

Security

Collateral pledged to
protect debtholders in
case of default.
Collateral trust bonds:

The order in
which debt

holders get paid.


Common stock held
by corporation used
Lower seniority
as security.
debt is called
Mortgage bonds.
Secured by mortgage on
subordinated.
real estate or other long
term asset.
Debt can
A blanket mortgage
pledges many assets
never be
owned by corporation.
Long Term Financing - Debt and
Chapters 15, 20 and 21
subordinated

Equity
Bonds that are

The Sinking Fund

Issuer makes annual payments to trustee

Each year, trustee buys back fraction of


bonds either at market value or at face
value, with bonds chosen via a lottery
Sinking funds provide extra protection to
bondholders.

Most start 5 to10 years after initial issuance.

Firm puts aside money for principal repayment.

Sinking funds provide the frm with an


option.

Bonds can be bought back at a price beneficial

Callable Bonds
44

Firm has the right, but not the obligation, to


call back (make debt holders surrender)
issue at a predetermined price at certain
points in time.
The call is often deferred company may
not call bond in frst few years of a bonds
life.
Sometimes there is a fxed call premium,
but most debt issues feature a Canada
plus call.

When bond is called, call premium is set to


Long Term Financing - Debt and
Chapters 15, 20 and 21
compensate
investors
for
the
diference
in
Equity

More on Callable Bonds


45

Callable bonds are more risky to debt


holders, therefore debt holders
demand a higher rate of interest to
ofset this risk.

Thus there should be no monetary advantage


to the firm in issuing callable bonds.

Why do frms then issue callable bonds?

Firms have better knowledge on future


interest rates.
Diferential tax rates between the firm and its
bondholders.
Long Term Financing
-undertake
Debt and
Chapters
15, 20 and 21
Firm opportunities
to
future
Equity

Bond Options
46

Convertible bonds.

Bond can be converted in to common


stock.

Exchangeable bonds.

Similar to convertible bonds but can be


exchanged for shares in another company,
which the issuer may already own.
It may also be exchanged for a bond of
a diferent type (e.g. fxed versus
foating coupon payments).
Long Term Financing - Debt and
Equity

Chapters 15, 20 and 21

Example of a Convertible
Bond

LO21.
5

More Bond Options


48

Put bonds and poison puts.

A bond that allows the bondholder to force


the issuer to repurchase the security at
specifed dates before maturity.
A poison put is triggered by a takeover
attempt.

Extendibility and retractability.

Extendible maturity can be increased


at option of bondholder.
Retractable bond can be redeemed
early at option of bondholder.

49

Covenants and Options and


Coupon Rates

Provisions in bond contract (either


covenant or option) that protect or
give advantage to bond holders will
ceteris paribus result in lower coupon
rates to investors.
Provisions in bond contract (either
covenant or option) that give advantage
to common shareholders (i.e. the frm)
will ceteris paribus result in higher
coupon rates to investors.

Zero Coupon Bonds

Bonds do not issue coupons and


are sold at a discount.
Signifcant call premium issued
at lower YTM.
Benefts to investor

PB Par n

Value
(1
k)

No reinvestment rate risk


when coupons received.
Bond is unlikely to be called.
Firms may purchase these bonds to
match assets with liabilities.

PB =Price of the
bond.

n = number of
periods to
maturity.

k = discount
rate or yield to
maturity.

Disadvantage to investor

Greater volatility when interest rates


fuctuate.

Tax implication: although interest


is not paid until maturity, both
Long Term
Financing - Debt and Equity
Chapters
15, 20 andand
21
investors
frms must
report

Price and Interest Rates


51

Pric
e

Coupon
Bond
ZeroCoupon
Bond

Long Term Financing - Debt and


Equity

Because there
are no
intermediate
payments, zero
coupon bonds
are more
sensitive than
coupon bonds
to changes in
interest rates.

Rate of
Interest
Chapters 15, 20 and 21

52

Floating Rate Bonds and


Interest Rates

Floating rate bonds ofer variable


coupons.
The coupon rate is tied to a
benchmark rate, such as:

Treasury rate.
Fed fund rate.
LIBOR.
Commercial paper rate.
Prime rate.

Upper and/or lower boundaries may be


placed on Long
the
Termcoupon
Financing - Debt and
rate. Chapters 15, 20 and 21
Equity

53

What Happens When Debt


Matures or When Interest
Rates
Change
As interest
rates , frms have the

incentive to call in debt and issue new


debt at lower interest rates.
When will this happen?
This is a NPV calculation:

Consider both the present value of costs


and benefits from refinancing.
Refinance if PV benefits > PV costs.
Instead of using k as the relevant
discount rate, we use ri = rb(1-Tc), the
after tax cost
the- Debt
new
issue.
Long Termof
Financing
and debt
Chapters
15, 20 and 21
Equity

Refunding Time Line


54

New Bond

Old Bond
Retired

Issued Invest
Proceeds

Anniversary of Old
Bond Issue &
Coupon date

Must pay Old


bondholders par
value, call premium
and accrued interest
since anniversary
date.

Tim
e

Bond could be
retired for face
value plus call
Long Term Financing - Calculated
Debt and
at Chapters
simple 15, 20 and 21
premium Equity
interest

Cost Calculation
Tax
Deducti
ble
No
Yes

Call Premium on old bonds


+ Interest that must be
paid on old debt during
overlap period
+ Issuing and Underwriting of
Sort of
The
newflotation
debt (i.e.,
the of
flotation
costs
new debt
costs) a tax shield that is earned
generate
(amortized) over 5 years.

Cost Calculation cont


56

If F is the face amount of the issue, and


p is the call premium, then total call
premium is pF.
Interest paid on the old debt during the
overlap period is

(1- TC )

c old Fisthwehelernegth

of overlap period.

1 1 5
E
i issuing
the

Let ETCbe
and u/w expense. If TC
r

5
r

is the frms
tax rate then the p.v. 1of1
the-5

E
i
TC r
tax
shield is
Total

5
i

pF

(1T
)c
F

cost is
C
old

r 15, 20 and 21
Long
Chapters
ETerm
- Financing - Debt and

Equity

Beneft Calculation
Tax
Deducti
ble
Yes

Interest earned on invested net


proceeds
+ PV interest savings over lifetime of
Yes
new debt issue
+ Unused tax shield from amortization
N/A
of issuing expenses of old bond
This
issue
last is only necessary if the old bond
issue has been called in before it is 5 years
old and typically most bonds cannot be called
within the first 5 years after issue.

Beneft Calculation cont


58

The net invested in the risk free account is FE. If it is invested for the overlap period at a
rate Rf, then the after tax interest earned is

F - E

Rf
1- Tc .
coupon
rate,
the periodic
interest
If F is the
facethen
amount
of the issue,
and cnew is
savings is F(cold- cnew)(1- Tc).
the new
Usually wont have to worry about
unamortized flotation costs from the old
bond, since many bonds have provisions
such
that they cant be called in the first
5
Benefit
-n
1- 1 ri
years.

therefore is

1 C
ne

F - E Rf 1 TC F w T
i

21
Long Term Financing - Debt
and
Chapters 15, 20 and
r
Equity

Example
59

Johnson Management is considering


whether to refund a $50 million, 20 year,
12% coupon rate bond issue that was
sold 5 years ago. The fotation costs on
the 12% bonds were 2 million. The $50
mil in new 15 year bonds would carry an
annual interest rate of 10%. A call
premium of 7% would be required to
retire the old issue and fotation costs of
$1.75 million would apply to the new
issue. TheLong
marginal
tax
is 30%,
Term Financing - Debt
and rateChapters
15, 20 andand
21
Equity

A Second Example
60

Clifton Inc. currently has $250 million of bonds


outstanding, with an annual coupon rate of 14% and a
remaining life of 25 years.

They were issued fve years ago with a foatation cost of


$1.5 million and the interest is paid annually.
From
5 to
9
15%
From
10 to
10%
than
The
indenture
allows
redemption
at
theGreater
following
call 5%
years after
15 years
15 years
premiums:

issue

after issue

after issue

Right now the frm could issue $250 million of 25 year


bonds at par with annual coupons of 11.5%. Interest rates
are not expected to decline further.
Floatation costs on the new bonds are $2.75 million.
There is one month overlap, and Cliftons tax rate is 36%
and the treasury bill rate is 9%.
Should the frm refund the existing bonds?
Long Term Financing - Debt and
Equity

Chapters 15, 20 and 21