The Wagner Corporation has a $27 million bond obligation outstanding, which it i

Question

The Wagner Corporation has a $27 million bond obligation outstanding, which it is considering refunding Though the bonds were initially issued at 8 percent, the interest rates on similar issues have declined to 6.5 percent. The bonds were originally issued for 20 years and have 16 years remaining. The new issue would be for 16 years. There is a 7 percent call premium on the old issue. The underwriting cost on the new $27 million issue is $620,000, and the underwriting cost on the old issue was $470,000. The company is in a 30 percent tax bracket, and it will allow one month overlap period. Treasury bills currently yield 3 percent. Use Roond tihe tini nvers to nearet whole dolinel Paces. do not round Intermediate calculations. a. Calculate the present value of total outflows. Total outflows b. Calculate the present value of total inflows. Total inflows c. Calculate the net present value. Net present value d. Should the old issue be refunded with new debt? O Yes O No

Explanation / Answer

Bond O/s 27000000 Issued Interest rate 8% Declined interest rate 6.50% Yrs to maturity 16 yrs Issued for 20 yrs New issue 16 yrs call premium 7% underwriting cost on new issue 620000 underwriting cost on old issue 470000 tax rate 30% treasury bills rate 3% overlap period 1 month a) Calculate the present value of total outflows: 1 Payment for call premium 27000000*0.07 1890000 After tax payment for call premium = 1890000*(1-0.35) 1228500 2 Underwriting cost on new issue 620000 Amortisation of above underwriting costs = 620000/16 38750 Tax savings on amortisation of costs = 38750*0.35 13562.5 Actual Expenditure 620000 Present value of tax savings in future is = 13562.50*12.5611 170359.9188 Using Appendix D we get 12.5611, N = 16 yrs , r = 0.03 Net cost of underwriting expense on new issue 449640.0813 The present value of total outflows (1+2) 1678140.081 b) Calculate the present value of total inflows: 1) Cost savings in lower interest rates 27000000*(0.08-0.065) 405000 After tax savings on interest rates 405000*(1-0.35) 263250 Present value of savings on interest rates = 263250*12.5611 3306709.575 2) Underwriting cost on old issue Original amount 470000 Amount which has been written off over 4 yrs - 470000*4/20 94000 Unamortised old underwriting costs 376000 Present value of deferred future write off 23500*12.5611 295185.85 Gain in old underwriting 80814.15 After tax value of underwriting = 80814.15*0.65 52529.1975 The present value of total inflows 3359238.773 c) Calculate the net present value PV of inflows 3359238.773 Less : PV of outflows 1678140.081 Net Present value 1681098.692 d) Since the NPV is positive, the old issue be refunded with new debt

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