BU393 Lecture Notes - Lecture 8: Refinancing, Net Present Value, Tax Shield
Document Summary
Replacing an issue of outstanding bonds is called bond refunding, which usually requires a company to call the entire issue of bonds at the call price. Callable bonds have zero-sum benefit for issuer and bondholder. If interests rates are low, bond prices go up, and the issuer can buy back the bond at the call price which is lower than the bond price and re-issue. However, bondholders factor this advantage into their valuation, and thus, require higher interest rates on callable bonds than non- callable bonds. Fro(cid:373) the fir(cid:373)"s sta(cid:374)dpoi(cid:374)t, refi(cid:374)a(cid:374)ci(cid:374)g is a project. The prese(cid:374)t value of costs and benefits from refinancing may be combined into an npv. The correct discount rate is the after-tax cost of the new debt issue. Call premiums: the amount you have to pay to call the bond you currently have in the market: not a tax deductible expense.
