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Refunding Discounted Debt: A Clarifying Analysis

Published online by Cambridge University Press:  06 April 2009

John D. Finnerty
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Abstract

This paper demonstrates that refunding discounted debt represents a form of tax arbitrage that is profitable to taxpaying corporations when the present value of the additional tax shields, created through the refunding, exceeds the sum of the present value of the overall increase in pre-tax debt service requirements, after-tax transaction costs, and any tax incurred on the gain. The paper contrasts the factors that give rise to profitable opportunities to refund high-coupon debt and discounted debt. It also shows that, of the analytical approaches previously suggested for calculating the net advantage of refunding discounted debt, discounting the change in after-tax debt service payments at the after-tax cost of money for the refunding issue is the only one consistent with preserving debt service parity.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 21 , Issue 1 , March 1986 , pp. 95 - 106
Copyright
Copyright © School of Business Administration, University of Washington 1986

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