BOND REFUNDING: CASE 24A .................................. 1
ABBOT NURSERY: CASE 72 .................................... 7
LEASE ANALYSIS: CASE 25A .................................. 16
FEDERAL FINANCE BANK: CASE 75 ............................. 23
1. What discount rate should be used to perform the refunding analysis? Discuss the relative merits of using the current after-tax bond interest rate as opposed to the weighted average cost of capital. (Hint: Think about the riskiness of cash flows from the refunding operation versus cash flows from a "typical" project.)
Using the average cost of capital is a lower risk approach than reliance on the current bond interest rate. The average cost of capital approach provides a more stable basis over the longer-term.
2. Calculate the net present value of refunding the 1991 issue if the firm refunds on January 1, 1996. Use either Table 1 or Table 2 as a guide for your analysis.
3. Critique the positions taken by the various board members. As part of your answer, calculate the expected NPV of refunding the 1991 bond a year from now, based on Killian's probability distribution of interest rates. Remember that if Shenandoah refunds next year, the old bonds will then have 24 years left to maturity. Assume for purposes of this question that the firm could issue the new bonds with a 24-year maturity. Also, remember that Shenandoah would not refund next year if the refunding had a negative NPV at that time.
Killian's probability distribution provides a discount rate of 10%. Refunding now, as opposed to refunding later will be financially beneficial for the company. Making the bonds callable in five years will protect against interest rate risk.
4. If the probability distribution of expected future interest rates was "tight" as opposed to "flat," i.e., if it had a small standard deviation, would this have any effect on the decision to refund now versus waiting? As...