CHAPTER

SIXTEEN

Long-term Debt and

Lease Financing

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PPT 16-1

EDI TI ON

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

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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.

Senior
Subordinated

Lower priority
of claims
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Subordinated debenture holders will not receive

payment unless designated senior debenture
holders are paid in full.

Preferred stock
Common stock
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PPT 16-3

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Table 16-1
Corporate bond record (partial)
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 year
thereafter on the interest payment date
Underwriter: Swiss Bank Corporation

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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 16-3
Long-term yields on corporate debt
20
18
16
14

Percent

12
10
8
6
4
2

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0
1979
1982
1985
Source : Bank of Ca nada Re view, March 1999, F1 se rie s.

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1988

1991

1994

1997

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Table 16-4
Outstanding debt issues, April 30, 1999
Issuer
Government of Canada
Government of Canada
Government of Canada
AA rating
Canadian Utilities
Canadian Utilities
Nav Canada
Nav Canada
A rating
Bombardier
Canadian Tire
Canadian Tire
BBB rating
Domtar
Domtar
Talisman
Cdn Occidental Petroleum
BB rating
Air Canada
B rating
Rogers Cable

Coupon Maturity Date

8.750
Dec 01/05
9.500
Jun 01/10
8.000
Jun 01/27

Price
119.96
135.45
136.58

Yield to Maturity
5.13
5.24
5.44

8.430
11.400
6.600
7.400

Jun 01/05
Aug 15/10
Dec 01/06
Jun 01/27

115.16
146.06
106.24
119.78

5.46
5.78
5.58
5.94

6.400
5.650
12.100

Dec 22/06
Jan 16/06
May 10/10

103.91
99.85
150.09

5.76
5.68
5.86

10.350
10.850
9.800
6.300

Sep 01/06
Aug 15/17
Dec 22/04
Jun 02/08

106.97
125.77
113.57
94.39

7.50
8.12
6.85
7.15

6.750

Feb 02/04

100.50

6.62

8.750

July 17/07

104.00

8.07

Source: www.canpx.ca

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Summary of bond refunding decision

Step CNet Present Value

Outflows (Costs)
1. Net cost of call
premium
. . . $1,000,000
2. Net cost of borrowing
expense on new issue
152,493
3. Duplicate interest
during overlap
period
. . .
20,000

Inflows (Benefits)
4. Cost savings in lower
interest rates

Present value of outflows $1,172,493

Net present value .

Present value of inflows

.

$1,720,488

$1,720,488

547,995

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Table 16-5
Examples of Eurobonds
Amount
Outstanding
Currency
Rating Coupon Maturity ($ millions) Denomination*

Merrill Lynch & Co., Inc.

Nippon Telephone & Telegraph
Petro-Canada
Procter & Gamble Co.
Sony Corporation
Telecom Corporation

A1
0.00%
Aaa 10.25%
Baa1 9.25%
Aa2 10.88%
Aa3 1.40%
Aa1 7.50%

2000
2001
2021
2001
2005
2003

100.0
200.0
300.0
200.0
300.0
100.0

DM
U.S.$
U.S.$
C$
Yen
N Z$

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

Block These are zero-coupon rate bonds.
Hirt Source: Moodys Bond Record, July 1998..
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Table 16-8
Net present value of borrow-purchase
(1)
PV of
CCA
Shield

(2)

(3)

(4)

(5)

Payment

Interest
Tax
Shield

Aftertax
Cost 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)

Year

(5,000)

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Or

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Cost of asset . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
PV of CCA shield . . . . . . . . . . . . . . . . . . . . . . . . . . . .
PV of borrowing alternative . . . . . . . . . . . . . . . . . . .

(5,000)
1,495
($3,505)
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PPT 16-9

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Table 16-9
Net present value of operating lease outflows
Year

Payment

Tax
Shield

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........

720

(720)

(538)
$4,339

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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 rate

Maturity Date:

date when repayment of principal is due

Indenture:
legal document detailing the corporations obligations
Secured Debt:

where specific assets are pledged in the event of default

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Debenture:

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 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:
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corporation can redeem bonds early by paying a

premium 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) 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
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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 market
conditions
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 average
cost of capital (WACC)

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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

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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 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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