Redunding Analysis for Bonds

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 refun

proach could be a useful approach for the company's excess cash. The earnings likely would be higher than they would with money market investments. Credit derivative instruments separate risk from funding. The holder of a credit risk instrument, thus, is required to provide funds only in situations where default occurs. The holder of the underlying credit contract (a) provides funds to the borrower and (b) pays a fee to the holder of the credit derivative instrument to assume the risk of default associated with the underlying credit contract. Credit derivative pricing refers to the process of establishing the value of the risk associated with a credit contract. The valuation process increases in complexity when a credit derivative instrument moves from coverage of a single underlying credit contract involving a single credit default risk swap to a portfolio default risk swaps. Portfolio default risk swaps represent one new development in the evolution of the credit derivative market. 9. Would your recommended strategy be the same for a company whose cash balances were projected to be in the millions of dollars as opposed to Abbot's thousands or if the forecasts showed cash surpluses for all future months as opposed to mo

Category: Economics - R