Case 15: Mirage Resorts

Las Vegas is one of the fastest growing and arguably the most exciting city in the United States. In fact, Las Vegas now has more visitors than Orlando or the entire state of Hawaii. The difference is, when people visit Orlando and Hawaii, they come to see theme parks and beaches and coincidentally stay in hotels. But, when people come to Las Vegas, they come to see its hotels.

Mirage Resorts owns several hotels along the Las Vegas strip: The Mirage, MGM Grand, Bellagio, New York-New York, and Treasure Island. When the Mirage hotel was first built, Mirage Resorts financed the project with 11% notes from the GNS Finance Corporation. These 20-year, $1,000 par, callable bonds had a face value of $40,000,000 and were issued in March of 1988. When they actually sold, they went at a discount at $970 each. The call price of each bond is $1,110. Further, when the bonds were originally issued, the floatation costs totaled $200,000. The unamortized debt discount is $39,065,000.

Today, interest rates have dropped substantially. Mirage Resorts is considering the possibility that it might be able to refund the old bond issue and replace it with a new issue that has a much lower coupon rate. After meeting with several investment bankers, Mirage learned they could get new bonds at a much lower coupon rate.

The new bonds are expected to sell at their par value of $1,000, have only an 8.5% coupon rate, and a 13-year maturity. Mirage estimates that there will be a two month overlapping period while it retires the old bond issue.

Goldman Sachs was chosen to underwrite the issue because of their reputation and relatively low floatation costs. The deal held that Goldman Sachs would receive a fixed amount of $120,000 to cover administration expenses plus a variable amount equal to .4% of the par value of the offering. The selling group would receive another .3% of the par value upon the offering.

Mirage Resorts has an after-tax cost of debt equal to 6% and their corporate tax rate is 35%.

Questions

1. Calculate the total floatation costs associated with the new bond issue.

2. What is the initial investment required to issue the new debt?

3. What is the annual cash flow from the old bond issue?

4. What is the annual cash flow from the new bond issue?

5. Calculate the annual cash flow savings associated with the new bond issue.

6. What is the present value of the annual cash flow savings associated with the new bond issue? (Hint: these saving will occur every year until the bond issue matures.)

7. Should Mirage refund the bond issue?

8. Mirage issued the debt only seven years ago. Why is it that they are able to get such a lower interest rate today? Do you think Mirage Resorts should have waited until interest rates had decreased in the first place before building the Mirage hotel?

9. What factor(s) do you think were most responsible for the decision you made? That is, of all the factors that affect the refunding decision, which ones do you feel tend to have the greatest impact?