In May 2016, Starbucks issued long-term debt in a registered public offering, which consisted of $500 million of 10-year 2.50% Senior Notes (the “2026 notes”) due June 2016. Interest on these Senior Notes is payable semi-annually on June 15 and December 15 of each year, commencing on December 15, 2016.
The cash payments to the 2016 Senior Note holders over the life of the note will be $750 million. This is based on twenty (20) interest payments of $12.5 million ($500 million x 2.50% x 6/12) for a total of $250 of interest payments plus $500 million at maturity.
Note: The Senior Notes are the same type of instrument as the bonds discussed in class.
A. Starbucks’ 2016 fiscal year ends October 31, 2016. Thus the fiscal year ended before Starbucks made its first interest payment on December 15, 2016. Explain whether Starbucks would recognize any interest expense during the 2016 fiscal year for these notes?
B. Assuming the Senior Notes were issued at par (i.e., the market rate equals the coupon rate at issuance), what would be Starbucks’ cash proceeds from the notes’ issuance?
C. Assume when the Senior Notes were originally issued in May 2016, the market demanded a (i.e., the effective rate was) 3.00 percent return. Explain whether Starbucks’ cash proceeds from the Senior Notes issuance would be greater than, less than, or the same as your answer in B above. Do not provide a numerical answer.
D. As stated in the introduction, Starbucks will pay $250 million in interest payments to the 2026 notes holders over the life of the notes. Explain whether the allocation to interest expense will be the same for the scenarios in B & C above. That is, would total interest expense over the 10-year life of the notes be the same if the notes were issued at a market rate of 2.50% or 3.00%.
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