Suppose your company needs to raise $36.9 million and you want to issue 24-year

Question

Suppose your company needs to raise $36.9 million and you want to issue 24-year bonds for this purpose. Assume the required return on your bond issue will be 9.4 percent, and you’re evaluating two issue alternatives: a 9.4 percent semiannual coupon bond and a zero coupon bond. Your company’s tax rate is 35 percent.

Requirement 1:

(a) How many of the coupon bonds would you need to issue to raise the $36.9 million? (Do not round intermediate calculations. Enter the whole number for your answer, not millions (e.g., 1,234,567).)

Number of coupon bonds _____________________

(b) How many of the zeroes would you need to issue? (Do not round intermediate calculations. Enter the whole number for your answer, not millions (e.g., 1,234,567). Round your answer to 2 decimal places (e.g., 32.16).)

Number of zero coupon bonds___________________

Requirement 2:

(a) In 24 years, what will your company’s repayment be if you issue the coupon bonds? (Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars (e.g., 1,234,567).)

Coupon bonds repayment $ _______________________________

(b) What if you issue the zeroes? (Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars (e.g., 1,234,567). Round your answer to the nearest whole dollar amount (e.g., 32).)

Zero coupon bonds repayment $ _______________________

Requirement 3: Assume that the IRS amortization rules apply for the zero coupon bonds. Calculate the firm’s aftertax cash outflows for the first year under the two different scenarios. (Do not round intermediate calculations. Input a cash outflow as a negative value and a cash inflow as a positive value. Enter your answers in dollars, not millions of dollars (e.g., 1,234,567). Round your answers to 2 decimal places (e.g., 32.16).)

Coupon bond cash flow $ _____________________

Zero coupon bond cash flow $_______________________

Explanation / Answer

Requirement 1. Required Rate of Return after tax = 9.4% x (1-0.35) = 6.11% Question a. if 9.4% required rate of return and bond is issued at 9.4% Coupon rate value of the bond is $1000 So required no of bond = 36,900,000/1000 = 36,900 bonds Question b. Present Value of 0% coupon Bond = 1000/(1+9.4/200)^48 =$110.29588 No of Zero% coupon bond = 36,900,000/110.29588=334,554.66 Requirement 2a. for Coupon Bond issued at 9.4%, The has to pay 36,900,000 along with 6 months interest. =36,900,000 x 1.047 = 38,634,300 Requirement 2b. if you issue zero coupon bonds at an issue price of 110.29588 per bond you have to Repay only $1000 per bond = 334554.66 x 1000= 334,554,660

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