Sld16 LT Debt and Lease Fin

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Long-term Debt andLease Financing

McGraw-Hill Ryerson McGraw-Hill Ryerson Limited 2000

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McGraw-Hill Ryerson Limited 2000

Foundations of FinancialManagement CANADIAN

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Figure 16-1Interest coverage - Canadian non-financial corporations

PPT 16-1

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Figure 16-2Priority of claims

PPT 16-2

SeniorJunior

Preferred stockCommon stock

Unsecured debt(debentures)

Senior

First claim on assets pledgedSecond claim on assets pledged

Remaining assets are distributed below.

Lower priorityof claims

Subordinated debenture holders will not receive payment unless designated senior debentureholders are paid in full.

Secured debt

Subordinated

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Table 16-1Corporate bond record (partial)

PPT 16-3

Air Canada

5.75% 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 SwF101.50 and at SwF102.00 every fifth yearthereafter 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 102.00

Underwriter: Swiss Bank Corporation

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Figure 16-3Long-term yields on corporate debt

0

2

4

6

8

10

12

14

16

18

20

1979 1982 1985 1988 1991 1994 1997

Source: Bank of Canada Review, March 1999, F1 series.

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PPT 16-4

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Table 16-4Outstanding debt issues, April 30, 1999

Issuer Coupon Maturity Date Price Yield to Maturity Government of Canada 8.750 Dec 01/05 119.96 5.13Government of Canada 9.500 Jun 01/10 135.45 5.24

Government of Canada 8.000 Jun 01/27 136.58 5.44

AA rating

Canadian Utilities 8.430 Jun 01/05 115.16 5.46

Canadian Utilities 11.400 Aug 15/10 146.06 5.78

Nav Canada 6.600 Dec 01/06 106.24 5.58

Nav Canada 7.400 Jun 01/27 119.78 5.94

A rating

Bombardier 6.400 Dec 22/06 103.91 5.76

Canadian Tire 5.650 Jan 16/06 99.85 5.68

Canadian Tire 12.100 May 10/10 150.09 5.86

BBB rating

Domtar 10.350 Sep 01/06 106.97 7.50

Domtar 10.850 Aug 15/17 125.77 8.12

Talisman 9.800 Dec 22/04 113.57 6.85

Cdn Occidental Petroleum 6.300 Jun 02/08 94.39 7.15

BB rating

Air Canada 6.750 Feb 02/04 100.50 6.62

B rating

Rogers Cable 8.750 July 17/07 104.00 8.07

PPT 16-5

Source: www.canpx.ca

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Outflows (Costs) Inflows (Benefits)1. Net cost of call 4. Cost savings in lower

premium . . . $1,000,000 interest rates $1,720,4882. Net cost of borrowing

expense on new issue 152,4933. 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

PPT 16-6

Summary of bond refunding decisionStep CNet Present Value

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Table 16-5Examples of Eurobonds

AmountOutstanding Currency

Rating Coupon Maturity ($ millions) Denomination*

Merrill Lynch & Co., Inc.

A1 0.00% 2000 100.0 DM

Nippon Telephone & Telegraph Aaa 10.25% 2001 200.0 U.S.$

Petro-Canada Baa1 9.25% 2021 300.0 U.S.$

Procter & Gamble Co. Aa2 10.88% 2001 200.0 C$

Sony Corporation Aa3 1.40% 2005 300.0 Yen

Telecom Corporation Aa1 7.50% 2003 100.0 N Z$

*DM is Deutsche mark, N Z $ is New Zealand dollar, and C$ is Canadian dollar.

These are zero-coupon rate bonds.

PPT 16-7

Source: Moodys Bond Record, July 1998..

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Table 16-8Net present value of borrow-purchase

(1) (2) (3) (4) (5)

Year PV ofCCA

Shield Payment

Interest Tax

Shield

AftertaxCost of

(2)-(3) Present Value at 6%

1 . . . . . . . . . . . . ($1,319) $500 x .4 $(1,119) $(1,056)

2 . . . . . . . . . . . . ($1,319) $418 x .4 (1,152) (1,025)

3 . . . . . . . . . . . . ($1,319) $328 x .4 (1,188) (997)

4 . . . . . . . . . . . . ($1,319) $229 x .4 (1,227) (972)

5 . . . . . . . . . . . . ($1,319) $120 x .4 (1,271) (950)

(5,000)

Or Cost of asset . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (5,000)PV of CCA shield . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,495PV of borrowing alternative . . . . . . . . . . . . . . . . . . . ($3,505)

PPT 16-8

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Table 16-9Net present value of operating lease outflows

Year Payment TaxShield

Aftertax Cost of Leasing

Present Value at 6%

0 . . . . . . . . $1,250 $ 0 $1,250 $1,250

1 . . . . . . . . 1,250 500 750 708

2 . . . . . . . . 1,800 500 1,300 1,157

3 . . . . . . . . 1,800 720 1,080 907

4 . . . . . . . . 1,800 720 1,080 855

5 . . . . . . . . 0 720 (720) (538)

$4,339

PPT 16-9

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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)

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Bond Terminology LT 16-2

Par Value:

principal or face value (usually $1,000)Coupon Rate:

actual or stated interest rateMaturity Date:

date when repayment of principal is due

Indenture:

legal document detailing the corporations obligationsSecured Debt:

where specific assets are pledged in the event of defaultDebenture:

a L/T unsecured corporate bond

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Priority of Claims LT 16-3

Secured Debt (first priority)

Unsecured Debt (or Debenture)

Preferred Shareholders

Common Shareholders (last to receive any money)

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Methods of Repayment LT 16-4

Principal at maturity:

lump-sum payment when bond is dueSerial payments:

bond is paid off in instalmentsSinking fund:

corporation contributes regularly to a trust fund usedto buy back bonds

Conversion:

bond can be converted into shares of common stock atthe option of the bondholder

Call feature:

corporation can redeem bonds early by paying apremium over par value

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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) interestpayments and payment at maturity to the currentmarket price of the bond

affected by current market interest rates

If rates , YTM , bond price

and bond rating

If rating high (low risk), YTM

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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 marketconditions

Real Return Bond

principal adjusted for inflation

Revenue Bond

security based upon cash flow

Eurobond:

bond issued in another country

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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 firms weighted averagecost of capital (WACC)

Disadvantages of Debt:

interest and principal must always be met when due,regardless of a firms financial position

agreements may restrict financial management in firm

poor use of debt may lower a firms stock price

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2 Types of Leases LT 16-8

Capital Lease (or Financing Lease):

equivalent to a purchase

must be shown on a firms balance sheet

ex., oil drilling equipment and airplanes

Operating Lease:

a conventional rental agreement

firm doesnt expect to own property

is not shown on a firms balance sheet

ex., automobiles and office equipment

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Advantages of Leasing LT 16-9

Loan may be more expensive / refused

May be no down payment on lease, usually down paymentwith loan

May have fewer restrictions than loan

Fixed payment on lease, but loan interest may vary withprime

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

Sld16 LT Debt and Lease Fin

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