1 課程 6:Refinancing * 再看一個資本預算的例題 * 再訪 Buy or Lease *Refinancing *How do we adjust discount rates to reflect risk?

2 An example- IM&C project

3

4

5 Buy or lease Steps: 1. Calculate the after-tax cash flows if the asset is leased and if it is purchased. 2. Calculate the present value of the after-tax cash outflows if leased and if purchased. 3. Compare the present value of the cost of leasing with the present value of the cost of borrowing to purchase.

6 Example: Podunk Corporation needs a new machine priced at $100,000 that has an expected life of 6 years. The firm may either lease the asset or borrow to purchase it. The firm's marginal tax rate is 34%. Podunk plans to discount all cash flows, including the asset's salvage value, at the after tax cost of borrowing because all of the cash flows are considered to be low risk. With both alternatives, Podunk bears all maintenance, insurance, and other related costs, which are expected to be $2,000 per year.

7 Lease: If the machine is leased, the annual lease payments will be six equal payments of $20,000 paid in advance. The lease contract does not require the lessee to purchase the machine at the end of the lease term. Purchase: If the machine is purchased, the firm plans to use ACRS rates for 5-year property. The machine is expected to be sold for its estimated salvage value of $5,000 at the end of six years. Podunk can finance the purchase with a 12% term loan requiring six equal end-of-year payments consisting of principal and interest.

8 Cash Flows: Leasing Alternative:

9

10

11

12 Potential Advantages to Leasing:  Flexibility  Financing  Convenience Liquidity Shifts of risk of obsolescence Effective depreciation of land Tax considerations

13 Potential Disadvantages to Leasing: Cost Lack of salvage value Difficulty of property improvements Noncancelability

14 Mortgage Refinancing Decision Falling interest rates create opportunities for refinancing because the option is now “in the money”. “Out of the money” mortgage may be refinanced for other reasons. Refinancing even in the case of falling rates may or may not be beneficial. To make a sound refinancing decision we must consider the benefit as well as the cost of refinancing.

15 Variables Influencing Refinancing Decision Cf.: Existing loan versus new loan 1.Mortgage type 2.Interest rate 3.Mortgage maturity 4.Prepayment penalty 5.Financing costs 6.Holding period

16 An illustration: The Original loan Assumptions Existing Mortgage ·Original loan amount$50,000 ·Interest Rate12 percent ·Term30 years ·Age of mortgage5 years ·Prepayment Penalty5 percent. Monthly payment

17 Parameters of new loan NEW MORTGAGE ·Loan Amount=Outstanding balance on old loan ·Interest rate= 10½ percent ·Term= 25 years ·Refinancing costs=3% ·Holding period=Hold mortgage until maturity ·Borrower's =13 percent opportunity rate

18 Refinancing Decision Determine Outstanding Balance on Old Loan First determine monthly payment $50,000=PV 12/12 =i 30 x 12=n PMT=$ This is the monthly payment on the existing mortgage.

19 Refinancing Decision Outstanding balance at the end of 5th year $514.30=PMT 12/12=i 25 x 12=n PV=$48,831 Therefore the outstanding balance on the old loan = $48,831

20 Refinancing Decision Determine Monthly Payment on New Loan Payment: $48,831=PV 10.5/12=i 25 x 12=n PMT=$461.05

21 Refinancing Decision Determine Cost of Refinancing Prepayment Penalty on existing loan =.05 x $48,831 =$2,442 Plus financing cost on new loan =.03 x $48,831 =$1,465 TOTAL : $3,907

22 Refinancing Decision Determine Benefit of Refinancing Monthly payments on existing loan=$ Less Monthly payments on new loan= $53.25 This means that we are investing $3,907 today in order to save $53.25 every month for the next 25 years.

23 Refinancing Decisions Determine Present Value of Savings Present value of savings $53.25=PMT 13 /12 =i 25 x 12=n PV=$4,721 Net present value=$4,721-3,907=$814. The refinancing is worth undertaking under our assumption. What is the yield on this mortgage refinancing investment?

24 Question:Shorter holding period What happens if we assume the borrower’s holding period is only 10 years? –1.The cost of refinancing, $3,907, will be the same. –2.The benefit of refinancing will change.

25 Determine Benefit of Refinancing 1. Monthly savings on mortgage payment Monthly payments on existing loan=$ Less Monthly payments on new loan= $53.25 This amount is equal to that under the first example, but we will receive this saving for only 120 months and not 300 months as was the case in the first example.

26 2. Lump sum saving Determine the outstanding balance on old loan at the end of 15 years. $514.30=PMT 12/12=i 15 x 12=n PV=$42,852 Determine the outstanding balance on new loan at the end of 10 years. $461.05=PMT 10.5/12=i 15 x 12=n PV=$41,709 Lump sum saving=42,852-$41,709=$1,143

27 Determine Present Value of Savings 1. PV of monthly savings $53.25=PMT 13 /12 =i 10 x 12=n PV=$3, PV of the lump sum savings -$1,143=FV 13 /12 =i 10 x 12=n PV=$ Net present value=$3, ,907=-$27.32 Therefore, we should not refinance if we plan to hold the mortgage for only 10 years. Question: Find the holding period that has NPV=0.

28 Refinancing Summary: Find present value of savings Subtract cost from PV of savings If positive NPV refinance If negative NPV do not refinance

29 Capital budgeting and risk Basic formula - CAPM adjusts risk- premium for project beta Note that what is relevant is the project beta, and not the beta of the company as a whole.

30 Weighted Average cost of Capital For projects that have the same risk as the company’s existing business, the company’s cost of capital is the correct discount rate. r asset =D/Vr debt +E/Vr equity  asset =D/V  debt +E/V  equity Example:  debt =0.2,  equity =1.2, D?V=0.4, E/V=0.6, r f =6.6%, r m =13.6% 1.  asset =0.8, r asset =6.6%+0.8(13.6%-6.6%)=12.2% or, 2. r debt =8%,r equity =15%, r asset =0.4*8%+0.6*15%=12.2%