you have decided to advance refund $10 million of outstanding debt that is calla

Question

you have decided to advance refund $10 million of outstanding debt that is callable in five years. the interest rate on the bonds is eight percent. new bonds can be issued at 6 percent. for every dollar of new debt issued, you will incur a five percent issuance cost. interest payments on the present issue are $800,000 per year, with no scheduled principal payments. how much new debt needs to be issued to realize defeasance of the present issue?

a) $10,004,400

b) $10,839,600

c) $11,410,105

d) $11,381,580

Explanation / Answer

Computation of the Present value of the collable debt(in $) year Interest PVF@6% Present value 1 800000                       0.94              754,640 2 800000                       0.89              711,992 3 800000                       0.84              671,688 4 800000                       0.79              633,672 5 800000                       0.75              597,600 Sub total 3,369,592 Present value of old debt@6% (10000000*0.747)               7,470,000 Sub Total             10,839,592 Add: issuance cost@5%                   541,980 New debt needs to be issued to realize defeasance of the present issue 11,381,572(approx)

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