Your company needs to raise $53 million to finance a new factory. You\'re evalua

Question

Your company needs to raise $53 million to finance a new factory. You're evaluating two different 20-year bonds to raise these funds: a coupon bond with an annual coupon rate of 8 percent; and a zero coupon bond. Your company's tax rate is 40 percent. Both bonds will have a par value of $1,000, and a required annual return of 8 percent with semi-annual compoundingg a-1. How many of the coupon bonds would you need to issue to raise the $53 million? Number of coupon bonds 53,000 a-2. How many of the zeroes would you need to issue? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Number of zero coupon bonds 254,454.09 b-1. In 20 years, what will your company's repayment be if you issue the coupon bonds? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, i.e. 1,234,567.) Coupon bonds repayment $53,000,000 b-2. What is the repayment if you issue the zeroes? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, i.e. 1,234,567.) Zeroes repayment $254,454,090 Calculate your company's total aftertax cash flow during the first year for each type of bond (don't include the initial amount raised). Don't forget to adjust the cash flow for taxes. (Do not round intermediate calculations and enter your answers in dollars, not millions of dollars, i.e 1,234,567.) c. Coupon bonds Zero coupon bonds Inflow Outflow $1,696,000

Explanation / Answer

a-1

Number of coupon bonds to sell = $53,000,000 / $1,000 = 53,000

a-2

The number of zero coupon bonds to sell would be:

Price of zero coupon bonds = $1,000/(1.04)40= $208.29

Number of zero coupon bonds to sell = $53,000,000 / $208.29 = 254,454.09

b-1

The repayment of the coupon bond will be the par value plus the last coupon payment times the number of bonds issued. So:

Coupon bonds repayment = 53,000($1,040) = $55,120,000

b-2

The repayment of the zero coupon bond will be the par value times the number of bonds issued, so:

Zeroes: repayment = 254,454.09 ($1,000) = $254,454,090

c)

The total coupon payment for the coupon bonds will be the number of bonds times the coupon payment. For the cash flow of the coupon bonds, we need to account for the tax deductibility of the interest payments. To do this, we will multiply the total coupon payment times one minus the tax rate. So:

Coupon bonds: (53,000)($80)(1 – .40)

Coupon bonds: $2,544,000 cash outflow

For the zero coupon bonds, the first year interest payment is the difference in the price of the zero at the end of the year and the beginning of the year. The price of the zeroes in one year will be:

P1= $1,000 / 1.04038

P1= $225.29

The Year 1 interest deduction per bond will be this price minus the price at the beginning of the year, which we found in part b, so:Year 1 interest deduction per bond = $225.29 – 208.29 = 17

The total cash flow for the zeroes will be the interest deduction for the year times the number of zeroes sold, times the tax rate. The cash flow for the zeroes in year 1 will be:


Cash flows for zeroes in Year 1 = (254,454.09)($17)(.40) = $1,730,287.81

Coupon bonds Outfolw 2,544,000 Zero coupon bonds Inflow 1,730,287.81

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