The Bowman Corporation has a bond obligation of $13 million outstanding, which i

Question

The Bowman Corporation has a bond obligation of $13 million outstanding, which it is considering refunding. Though the bonds were initially issued at 10 percent, the interest rates on similar issues have declined to 8.4 percent. The bonds were originally issued for 20 years and have 10 years remaining. The new issue would be for 10 years. There is a call premium of 9 percent on the old issue. The underwriting cost on the new $13,000,000 issue is $430,000, and the underwriting cost on the old issue was $320,000. The company is in a 35 percent tax bracket, and it will use an 12 percent discount rate (rounded aftertax cost of debt) to analyze the refunding decision. Use Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods.

a. Calculate the present value of total outflows.(Do not round intermediate calculations and round your answer to 2 decimal places.)

b. Calculate the present value of total inflows.(Do not round intermediate calculations and round your answer to 2 decimal places.)

c. Calculate the net present value. (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places.)

Explanation / Answer

a) Calculation of present value of outflow:- Particulars Type Calculations Amount Repayment of old bond with premium Outflow =13000000*109%         14,170,000.00 Net proceeds from new issue (i.e. Value of bond-issue cost-discount) Inflow =13,000,000-430,000       (12,570,000.00) Tax saving on premium paid Inflow =13000000*9%*35% (409500.00) Tax saving on unamortized underwriting csot Inflow =320,000*35%             (112,000.00) Net initaial outflow           1,078,500.00 Hence the present value of outflow =$1,078,500.00 b) Calcuation of annual saving / annual cash inflow Particulars Type Calcualtion Amount Annual saving in interest Inflow =13000000*(10%-8.40%) 208000 Decrease in tax saving on interest Outflow =Saving in interest*35%               (72,800.00) Increase on tax saving on underwriting cost Inflow see note 1:- (43000-32000)*35%                    3,850.00 Annual saving/inflow               139,050.00 Note:-1 Previously annual underwriting cost was 320000/10 =$32000 per year not it will be 430000/10 =$43000 per year Note2:- The underwriting cost is amortized over the life of the bond. Present value of inflow = 139,050.00*PVIFA(12%,10) =139050*5.650223 =785,663.51 Hence the present value of inflow = $785,663.51 C) NPV= Present value of inflow- Present value of outflow =$785,663.51-$1,078,500.00 =-$292,836.49 Please feel free to ask if you have any query in the comment section.

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