Retiring Debt Early Smith & Company issued $80 million maturity value of 5-year

Question

Retiring Debt Early

Smith & Company issued $80 million maturity value of 5-year bonds, which carried a coupon rate of 6% and paid interest semiannually.

At the time of the offering, the yield rate for equivalent risk-rated securities was 8%.

Two years later, market yield rates had risen to 10%, and since the company no longer needed the debt financing, executives at Smith & Company decided to retire the debt.

Calculate the gain or loss that Smith & Company will incur as a consequence of retiring the debt early.

Is the early retirement of the debt a good decision if Smith & Company does not need the financing?

Explanation / Answer

Present Value after 2 year at 8% yield rate: Semiannual Coupon Maturity pv factor Present Period Interest Value Cashflows at 8% Value 5 $ 2,400,000.00 $    2,400,000.00 0.92592593 $    2,222,222.22 6 $ 2,400,000.00 $    2,400,000.00 0.85733882 $    2,057,613.17 7 $ 2,400,000.00 $    2,400,000.00 0.79383224 $    1,905,197.38 8 $ 2,400,000.00 $    2,400,000.00 0.73502985 $    1,764,071.65 9 $ 2,400,000.00 $    2,400,000.00 0.6805832 $    1,633,399.67 10 $ 2,400,000.00 $ 80,000,000.00 $ 82,400,000.00 0.63016963 $ 51,925,977.26 Total $ 61,508,481.34 Present Value after 2 year at 10% yield rate: Semiannual Coupon Maturity pv factor Present Period Interest Value Cashflows at 8% Value 5 $ 2,400,000.00 $    2,400,000.00 0.90909091 $    2,181,818.18 6 $ 2,400,000.00 $    2,400,000.00 0.82644628 $    1,983,471.07 7 $ 2,400,000.00 $    2,400,000.00 0.7513148 $    1,803,155.52 8 $ 2,400,000.00 $    2,400,000.00 0.68301346 $    1,639,232.29 9 $ 2,400,000.00 $    2,400,000.00 0.62092132 $    1,490,211.18 10 $ 2,400,000.00 $ 80,000,000.00 $ 82,400,000.00 0.56447393 $ 46,512,651.84 Total $ 55,610,540.08 Present Value at 8% after 2 year $ 61,508,481.34 Present Value at 10% after 2 year $ 55,610,540.08 Net Benefit can be received $    5,897,941.26 SO, Retirement of Bond is a good decision.

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