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Cases in Healthcare Finance, 5th Edition Copyright 2014 by FACHE CASE 16 QUESTIONS SENIOR CARE ENTERPRISES Bond Refunding 1. Aram Catalan has proposed that the company call the 8.0 percent bonds at first opportunity and replace them with a new, lower coupon rate issue. What is the NPV of the bond refunding in this situation? Assume annual coupons throughout the case. 2. Pamela Mathias is opposed to calling the bonds because she thinks this would not be well received by the major institutions that hold Senior Care's outstanding bonds. a. What do you think about Mathias' argument? b. If the bond was called after five years, what would be the realized 5-year yield-to-call for investors? c. Assume that investors had a 30-year investment horizon when the bonds were originally purchased. If the bond was called after five years and the proceeds reinvested for 25 years, what would be the realized 30-year rate of return for investors? (Hint: Create a 30-year timeline.) d. Compare the realized 30-year rate of return in c. to the original 8.0 percent coupon rate (with call provision) and the original 7.3 percent coupon rate (without call provision.) Would investors be fully compensated for call risk if the bond was called after five years? 3. Vincent Marchiano is opposed to calling the bonds now because he thinks that the decline in interest rates is not yet over and that refunding should occur one year hence. a. What is the NPV of the bond refunding (in today's dollars) in this situation? Hint: Calculate the expected NPV of refunding next year based on the probability distribution of interest rates given in the case. In doing this, remember that: (1) If the NPV at a particular interest rate is negative, then Senior Care would not refund; (2) one year from now there will be 24 years remaining on the old bond, so assume the maturity of the new issue will be 24 years, and; (3) future dollars must be discounted and the interest rate one-year hence is relatively uncertain. b. What do you think about Marchiano's argument? c. In general, how might the current shape of the yield curve influence the decision as to refund now versus later? 4. Kim Mitchell has lots of questions and wants to fully understand all of the risks and returns before making a decision. More specifically, she wants to know: a. How sensitive is the refunding NPV to changes in interest rates and what does this imply for the risk of the refunding decision? Graph the relationship between refunding NPV and interest rate (use a range of 4 to 10 percent.) What is the breakeven interest rate? b. How sensitive is the refunding NPV to changes in tax rates and what does this imply for the risk of the refunding decision? Graph the relationship between refunding NPV and tax rate (use a range of 10 to 70 percent.) What is the optimal tax rate? Briefly explain the shape of the curve. c. What happens if there is a downgrade in Senior Care's bond rating? Suppose the major bond rating agencies unexpectedly downgrade Senior Care's credit rating from A to triple-B before the firm could initiate the refunding, resulting in a 7.5 percent coupon rate and flotation costs of 1.5 percent on the new issue. How would these changes affect the refunding decision? d. What would happen if Senior Care was (and always had been) a not-for-profit provider? Assume that the relevant interest rates are 75 percent of the rates given to account for the fact that the debt would be tax exempt. Compare the NPV of the refunding assuming Senior Care was a not-for-profit to the original refunding NPV in question 1. 11/18/2013 Case Questions Cases in Healthcare Finance 5. Considering your answers to questions 1-4, do you recommend that Senior Care refund the bonds now (Catalan), one year from now (Marchiano), or not at all (Mathias)? 6. In your opinion, what are three key learning points from this case? Questions - 2