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Retiring debt will have both long-term and short-term cash flow implications. Is there a formula that...

Retiring debt will have both long-term and short-term cash flow implications. Is there a formula that facilitates a quick decision as to whether to retire debt or not?

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Answer #1

Whether to retire debt or not can be determined using the NPV formula.

The immediate cash outflow for retiring debt would be the total amount refunded.

The cash inflows would be the after-tax savings in interest expense over the remaining maturity of the debt, and the principal payable at the maturity of the bonds.

Using the cost of capital as the discount rate, the present value of the after-tax interest savings and the amount payable at maturity should be calculated. If this value is higher than the total amount refunded now, then the debt should be retired.

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