Suppose your company needs to raise $53 million and you want to issue 20-year bo
ID: 2650346 • Letter: S
Question
Suppose your company needs to raise $53 million and you want to issue 20-year bonds for this purpose. Assume the required return on your bond issue will be 8 percent, and youre evaluating two issue alternatives: A 8 percent semiannual coupon bond and a zero coupon bond. Your companys tax rate is 40 percent.
In 20 years, what will your companys repayment be if you issue the coupon bonds? (Enter your answer in dollars, not millions of dollars, i.e. 1,234,567.)
What if you issue the zeroes? (Enter your answer in dollars, not millions of dollars, i.e. 1,234,567.)
Calculate the aftertax cash flows for the first year for each bond. (Enter your answer in dollars, not millions of dollars, i.e. 1,234,567.)
Suppose your company needs to raise $53 million and you want to issue 20-year bonds for this purpose. Assume the required return on your bond issue will be 8 percent, and youre evaluating two issue alternatives: A 8 percent semiannual coupon bond and a zero coupon bond. Your companys tax rate is 40 percent.
Explanation / Answer
Answer A-1 )
Considering one bond with a face value of $ 1000
As the required rate of return on bond = coupon rate
Bonds are valued at par
So , the number of bonds = 53,000,000 / 1000 = 53,000
Answer a-2 )
for Zero coupond bonds
N=20 * 2 = 40
I/Y = 8 / 2 = 4 %
PMT = 0
FV = 1000
So, from the formula , PV = $ 208.29
So the number of zero coupon bonds = 53,000,000 / 208.29 = 254,454.09
Answer b-1 )
For coupon bonds, Company pay each half of the year the coupon = 40 * 53000 = $ 2,120,000
So the coupon paid for 20 years = 40 * 2,120,000 = 84,800,000
And then the principle repayment is done in 20th year = 53,000,000
Answer b-2 )
Repayment for Zero coupon bonds = Number of bonds * 1000 ( As there is no coupon so this is principle repayment)
= 254,454.09 * 1000
= $ 254,454,090
Answer C )
After First year , Coupon bond Cash Outflow = 2,120,000 * 2 = $ 4,240,000
This is an interest payment by company so company must receive tax benefit towards this.
Cash Inflow due to tax = 4,240,000 * 0.4 = 1,696,000
Effective cash outflow after considering tax benefits = 4,240,000 - 1,696,000 = $ 2,544,000
For zero coupon bonds company will not pay any coupons during any of the years
So the cash ouflow / Inflow = 0
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