Suppose your company needs to raise $53 million and you want to issue 20-year bo
ID: 2650497 • 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 you’re evaluating two issue alternatives: A 8 percent semiannual coupon bond and a zero coupon bond. Your company’s tax rate is 40 percent.
In 20 years, what will your company’s 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 you’re evaluating two issue alternatives: A 8 percent semiannual coupon bond and a zero coupon bond. Your company’s tax rate is 40 percent.
Explanation / Answer
a-1 Present value of the bond (Amount to be raised= PV of coupons + PV of face value at maturity semi annual coupon amount (PMT) = $ 53000000 * 8% /2 = $ 2120000 Semi annual (i) = 0.08 / 2=0.04 No of periods (n) = 20 years *2 = 40 semi annual periods Selling price of the bond = PMT *[ ( 1 - (1+ i)^-n) / i ] + FV / (1+ i)^n 2120000 [ 1 -(1.04)^-40 / 0.04] + 53000000 / 1.04^40 41960680.63 + 11039319.37 53000000.000 For a face value of $ 1000 No.of bonds that need be issued will be 53000000/1000 =53000 coupon bonds a-2 For a zero coupon bond -as it is issued @ a discount, PV = 53000000 With rest of the values as above amt .- ie. Future Face value will be FV =PV(1+i)^t Where PV=53000000;i=0.08;t=20 periods ie.FV=53000000 (1.08)^20 FV= 247030729 No.of bonds to be issued will be 247030.729 ie.247031 zero coupon bonds b-1 Company's repayment On Coupon bonds Semi annual int.payments is the PV of an annuity where, PV= 53000000; i=0.04 ; n= 40 periods; pmt.=? ie. 53000000= Pmt.(1-(1+0.04)^-40 )/ 0.04 ie. Pmt. Ie. Semi annual int.payments= 2677741 Total towards interest will be 2677741*40= 107109640 Towrdas principal 53000000 Total 160109640 On Zero Coupon bonds No.of bonds* Face value= 247031*1000= 247031000 c) The aftertax cash outflows for the first year for each bond On Coupon bonds Annual interest paid =2677741*2 less tax saved on this amt. ie. (2677741*2)- 2142193 = 3213289 On Zero Coupon bonds Face value 247031000 Issue value 53000000 Discount to be amortised over 20 yrs. 194031000 This discount is to be amortised annually @ the reqd.rate of return ie.8%(non-cash item) & shield due to tax savings on this amount reduces the cash flow to that extent Reduction inCash outflow=Tax Savings due to annual amortisation expenses of 8% of 247031000 ie.19762480 Shield due to Tax savings= 40% of 19762480 = 7904992 After-tax cash flows increase by this amount-7904992
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