bond buy back analysis - need help please

CFA General
#1

Hi everyone need some input here if possible. Say if a company is looking to buy back one of two bond issues and did an NPV analysis on both. What discount rate should be used, should it just be the current WACC? Or should a different WACC be used to for each of the NPVs, taking into account how the debt buyback would actually impact the WACC? Thanks in advance

#2

current YTM and if company buys back < par then positive NPV.

#3

so I will have 2 discount rates in total then, one YTM for each? The bonds are callable so there will be a prem.

#4

Rather than NPV, try calculating the IRR of each alternative. View it as the company having excess cash on its balance sheet and it has two competing investment alternatives - it just so happens that those alternatives are both debt instruments issued by the company iteself. The higher IRR will lead you to the better of the two alternatives and remove the need for you to choose and defend a discount rate in an NPV analysis.

#5

Thanks annonymous, I already did the IRR analysis. And I am farily certain on which one is a better choice, however this is analysis is going to goto some pretty highups (board perhaps) and I wanted some $ numbers as it is easier to understand.

#6

What’s the logic for using the company’s WACC and not the YTM (coupon, assuming the issue is at par) of the new bond?

Thanks!

#7

If you lower the WACC by repurchasing the bonds, you lower the YTM, and vice versa.

In short, it makes no difference which you use.

#8

S2000magician but in this specific case I’m evaluating, the YTM of the bond is lower than the WACC so I get different NPVs depending on which one I use. Can you better explain the logic for using either of one? What about the cost of equity, can it be used?

Thanks!