Long-term Debt and Lease Financing C H A P T E R S I X T E E N
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1 Long-term Debt and Lease Financing C H A P T E R S I X T E E N
2 Figure 16-1 Interest coverage - Canadian non-financial corporations PPT 16-1
3 Figure 16-2 Priority of claims Secured debt Senior Junior Unsecured debt (debentures) First claim on assets pledged Second claim on assets pledged Remaining assets are distributed below. PPT 16-2 Senior Subordinated Lower priority of claims Subordinated debenture holders will not receive payment unless designated senior debenture holders are paid in full. Preferred stock Common stock
4 Table 16-1 Corporate bond record (partial) Air Canada PPT % Subordinated Perpetual Bonds 1986 Issued: SwF200,000,000 Jan. 1, 1986 Euro O/S: SwF200,000,000 Dec. 31, 1997 Interest: 5.75% (A) Feb. 7 Redemption: Redeem. on Feb. 7, 1999 at SwF and at SwF every fifth year thereafter on the interest payment date Underwriter: Swiss Bank Corporation 5.25% Subordinated Perpetual Bonds 1986 Issued: SwF300,000,000 Jan. 1, 1986 Euro O/S: SwF300,000,000 Dec. 31, 1997 interest 6.25% (A) Jan.22 Redemption: Redeem. On Jan.22, 2001 and every fifth year thereafter at SwF Underwriter: Swiss Bank Corporation
5 Figure 16-3 Long-term yields on corporate debt PPT 16-4 Percent Source : Bank of Canada Review, March 1999, F1 series.
6 Table 16-4 Outstanding debt issues, April 30, 1999 PPT 16-5 Issuer Coupon Maturity Date Price Yield to Maturity Government of Canada Dec 01/ Government of Canada Jun 01/ Government of Canada Jun 01/ AA rating Canadian Utilities Jun 01/ Canadian Utilities Aug 15/ Nav Canada Dec 01/ Nav Canada Jun 01/ A rating Bombardier Dec 22/ Canadian Tire Jan 16/ Canadian Tire May 10/ BBB rating Domtar Sep 01/ Domtar Aug 15/ Talisman Dec 22/ Cdn Occidental Petroleum Jun 02/ BB rating Air Canada Feb 02/ B rating Rogers Cable July 17/ Source:
7 Summary of bond refunding decision Step C Net Present Value PPT 16-6 Outflows (Costs) Inflows (Benefits) 1. Net cost of call 4. Cost savings in lower premium... $1,000,000 interest rates $1,720, Net cost of borrowing expense on new issue 152, Duplicate interest during overlap period... 20,000 Present value of outflows $1,172,493 Present value of inflows $1,720,488 Net present value.... $ 547,995
8 Table 16-5 Examples of Eurobonds PPT 16-7 Amount Outstanding Currency Rating Coupon Maturity ($ millions) Denomination* Merrill Lynch & Co., Inc. A1 0.00% DM Nippon Telephone & Telegraph Aaa 10.25% U.S.$ Petro-Canada Baa1 9.25% U.S.$ Procter & Gamble Co. Aa % C$ Sony Corporation Aa3 1.40% Yen Telecom Corporation Aa1 7.50% N Z$ *DM is Deutsche mark, N Z $ is New Zealand dollar, and C$ is Canadian dollar. These are zero-coupon rate bonds. Source: Moody s Bond Record, July
9 Table 16-8 Net present value of borrow-purchase Year PV of CCA Shield (1) (2) (3) (4) (5) Payment Interest Tax Shield Aftertax Cost of (2)-(3) Present Value at 6% PPT ($1,319) $500 x.4 $(1,119) $(1,056) ($1,319) $418 x.4 (1,152) (1,025) ($1,319) $328 x.4 (1,188) (997) ($1,319) $229 x.4 (1,227) (972) ($1,319) $120 x.4 (1,271) (950) (5,000) Or Cost of asset (5,000) PV of CCA shield ,495 PV of borrowing alternative ($3,505)
10 Table 16-9 Net present value of operating lease outflows PPT 16-9 Year Payment Tax Shield Aftertax Cost of Leasing Present Value at 6% $1,250 $ 0 $1,250 $1, , , ,300 1, , , , , (720) (538) $4,339
11 Chapter 16 - Outline LT 16-1 Bond Terminology More Bond Terminology Priority of Claims Methods of Repayment 3 Types of Bond Yields Other Forms of Bond Financing Advantages and Disadvantages of Debt 2 Types of Leases Advantages of Leasing Lease vs. Borrow to Purchase (See PPT 16-8 and 16-9)
12 Bond Terminology LT 16-2 Par Value: principal or face value (usually $1,000) Coupon Rate: actual or stated interest rate Maturity Date: date when repayment of principal is due Indenture: legal document detailing the corporation s obligations Secured Debt: where specific assets are pledged in the event of default Debenture: a L/T unsecured corporate bond
13 Priority of Claims LT 16-3 Secured Debt (first priority) Unsecured Debt (or Debenture) Preferred Shareholders Common Shareholders (last to receive any money)
14 Methods of Repayment LT 16-4 Principal at maturity: lump-sum payment when bond is due Serial payments: bond is paid off in instalments Sinking fund: corporation contributes regularly to a trust fund used to buy back bonds Conversion: bond can be converted into shares of common stock at the option of the bondholder Call feature: corporation can redeem bonds early by paying a premium over par value
15 3 Types of Bond Yields LT 16-5 Nominal Yield (or Coupon Rate): stated yield Current Yield: yield in terms of the current price of the bond Yield-to-Maturity (YTM): interest rate that equates the future (expected) interest payments and payment at maturity to the current market price of the bond affected by current market interest rates If rates, YTM, bond price and bond rating If rating high (low risk), YTM
16 Other Forms of Bond Financing LT 16-6 Zero-Coupon Bond / Strip Bond: do not pay interest are issued at a deep discount from face value Floating Rate Bond: interest rate paid on the bond changes with market conditions Real Return Bond principal adjusted for inflation Revenue Bond security based upon cash flow Eurobond: bond issued in another country
17 Advantages and Disadvantages of Debt LT 16-7 Advantages of Debt: interest payments are tax deductible to a firm financial obligation is fixed wise use of debt may lower a firm s weighted average cost of capital (WACC) Disadvantages of Debt: interest and principal must always be met when due, regardless of a firm s financial position agreements may restrict financial management in firm poor use of debt may lower a firm s stock price
18 2 Types of Leases LT 16-8 Capital Lease (or Financing Lease): equivalent to a purchase must be shown on a firm s balance sheet ex., oil drilling equipment and airplanes Operating Lease: a conventional rental agreement firm doesn t expect to own property is not shown on a firm s balance sheet ex., automobiles and office equipment
19 Advantages of Leasing LT 16-9 Loan may be more expensive / refused May be no down payment on lease, usually down payment with loan May have fewer restrictions than loan Fixed payment on lease, but loan interest may vary with prime Lease from manufacturer may have attractive terms (ex: lower interest cost) or provide specialist expertise May restrict creditor claims in bankruptcy Equipment may have rapid obsolescence (ex: computers) May be tax advantages
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