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Multiple choice

Which of the following statements is most correct?

a. If new debt is used to refund old debt, the correct discount rate to use in discounting cash flows is the before-tax cost of new debt.

b. The key benefit associated with refunding debt is the reduction in the firm's debt ratio and creation of reserve borrowing capacity.

c. The mechanics of analyzing the NPV of a refunding decision are fairly straightforward. However, the decision of when to refund is not as clear because it requires a forecast of future interest rates.

d. If a firm with a positive NPV refunding project delays refunding and interest rates rise, the firm can still claim the entire interest savings by locking in a low coupon rate when the rates are low, even though it refunds the debt after rates rise.

e. If a firm is considering refunding and interest rates rise, this would tend to lower the expected price of the new bonds which will make them cheaper to the firm and increase the expected interest savings.

Discuss fully the reason for your choice to earn full credit.

Solution Preview

The correct answer is
d. If a firm with a positive NPV refunding project delays refunding and interest rates rise, the firm can still claim the entire interest savings by locking in a low coupon rate when the rates are low, even though it refunds the debt after rates rise.

This is correct. The new bond issue and the refunding of old bonds are different decisions. So new bonds can be issued when the ...

Solution Summary

The solution explains some multiple choice questions relating to new debt, old debt, discount rates, NPV and more

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