Hello,

I have prepared a report to my teacher as below. Can you please review and give some comments before I submit?

Kind regards,

Shigemi

Question:

Assume that you are the CFO of a company that intends to issue bonds to finance a new manufacturing facility.A subordinate suggests lowering the coupon rate on the bond to lower interest expense and to increase the profitability of your company.Is the rationale for this suggestion a good one?Explain.

My Answer :

I don't think the rationale for this suggestion is a good one because it would not lower interest expense.

All bonds have a face value and a coupon rate, and the coupon rate is the fixed interest paid to a bondholder by an issuing company.A bond with a $1,000 face value and a 5% coupon rate is going to pay $50 in interest irrespective of an actual bond price.If a coupon rate on bonds is less competitive than market rate, a company may need to sell the bonds at a discount (below face value). However, the company still needs to pay the fixed interest of $50 to bondholders. In this case, the company can fund less cash, but the interest expense is no change.On the other hand, if a coupon rate has competitiveness to market rate, the actual bond price could be sold at premium (above face value).This could generate more cash to the company, but the interest expense of $50 remains unchanged.

The coupon rate on bonds should be determined by taking market rate into consideration to attain an intended funding.