Question

Retiring Debt Early.

Smith & Company issued $100 million maturity value of six-year bonds, which carried a coupon rate of six percent and paid interest semiannually. At the time of the offering, the yield rate for equivalent risk-rated securities was eight percent. Two years later, market yield rates had risen to ten percent, 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? What factors should be considered in making this decision?

Answer 1

The early retirement of debt is something that is dependent on many factors. If the company does not need funds and it can retire the debt at lower prices then its face value then it is a kind of desirable situation and it should be able to do so. The other factors to consider is the interest rate in the market and the rate at which the company can borrow the funds from the market. If the company can borrow at cheaper rates from the market then refinancing is a better option for the company from the perspective of the cost of loan. If the company does have more than sufficient cash balance then it does make sense to reduce the level of debt. The company also has to consider its capital expenditure needs.