BOND REFUNDING: A CLARIFYING ANALYSIS.

The decision to refund a bond issue involves two questions: (1) Is it profitable to call an outstanding bond issue in the current period and replace it with a new issue? (2) Even if refunding now is profitable, would it be more profitable still to postpone refunding until a later period? In this paper we address ourselves to the problem of evaluating a bond refunding. The question of timing the refunding operation is not treated directly but, since proper evaluation of the benefits of refunding either now or in the future is essential to any timing strategy, the present analysis has a bearing on the timing decision. Although bond refunding has been widely recognized as a problem in capital budgeting, a survey of the literature reveals persistent disagreement on the appropriate method for evaluating the net benefits of bond refunding. Furthermore, none of the methods proposed in the literature has been derived explicitly from or shown to be consistent with the objective of maximizing shareholder wealth. In this paper we develop an analytical framework for the evaluation of a refunding operation which is rooted in security valuation theory. This is done by examining the link between the refunding decision and the valuation of a firm's securities in the market. The next section examines the different approaches to measuring the profitability of a refunding operation, the second section outlines a new approach, and the third section details the advantages of the new approach. [ABSTRACT FROM AUTHOR]