\"Break-even\" interest rate = What is the break even interest rate and after ta

Question

"Break-even" interest rate =

What is the break even interest rate and after tax of new debt?

Chapter: 18 Problem: 8 Schumann Shoe Manufacturer is considering whether or not to refund a $70 million, 10% coupon, 30-year bond issue that was sold 8 years ago. It is amortizing $4.5 million of flotation costs on the 10% bonds over the issue's 30-year life. Schumann's investment bankers have indicated that the company could sell a new 22-year issue at an interest rate of 8 percent in today's market. Neither they nor Schumann's management anticipate that interest rates will fall below 6 percent any time soon, but there is a chance that interest rates will increase. A call premium of 10 percent would be required to retire the old bonds, and flotation costs on the new issue would amount to $5 million. Schumann's marginal federal-plus-state tax rate is 40 percent. The new bonds would be issued 1 month before the old bonds are called, with the proceeds being invested in short-term government securities returning 5 percent annually during the interim period. Current bond issue data Par value $     70,000,000 Coupon rate 10% Original maturity 30 Remaining maturity                     22 Original flotation costs $       4,500,000 Call premium 10% Tax rate 40% Refunding data Coupon rate 8.0000% Maturity                     22 Flotation costs $       5,000,000 Time between issuing new bonds and calling old bonds (months) 1 Rate earned on proceeds of new bonds before calling old bonds (annual) 5% a. Perform a complete bond refunding analysis. What is the bond refunding's NPV? Initial investment outlay to refund old issue: Call premium on old issue = $ 7,000,000.00 After-tax call premium = $ 4,200,000.00 New flotation cost = $ 5,000,000.00 Old flotation costs already expensed = $ 1,200,000.00 Remaining flotation costs to expense = $ 3,300,000.00 Tax savings from old flotation costs = $ 1,320,000.00 You get to expense the remaining flotation costs Additional interest on old issue after tax = $     350,000.00 This is interest paid on the old bond issue between when the new bonds are issued and the old bonds are retired Interest earned on investment in T-bonds after tax = $     175,000.00 This is interest earned on the proceeds from the new bonds before they are used to pay off the old bonds. Total investment outlay = $ 8,055,000.00 Annual Flotation Cost Tax Effects: Annual tax savings on new flotation = $       90,909.09 Tax savings lost on old flotation = $       60,000.00 Total amortization tax effects = $       30,909.09 Annual interest savings due to refunding: Annual after tax interest on old bond = $ 4,200,000.00 Annual after tax interest on new bond = $ 3,360,000.00 Net after tax interest savings = $     840,000.00 Annual cash flows = $     870,909.09 After-tax cost of new debt = NPV of refunding decision = $ 3,408,778.61 b. At what interest rate on the new debt is the NPV of the refunding no longer positive? At less than 8% Use Goal Seek to set cell D60 to zero by changing cell C27.

"Break-even" interest rate =

What is the break even interest rate and after tax of new debt?

Explanation / Answer

What is the break even interest rate and after tax of new debt? "Break-even" interest rate = Break Even Interest rate = Rate/(1- tax rate) Break Even Interest rate = 8%x/(1-40%) 13.33%

Related Questions

Navigate

• Browse (All)
• Browse #
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.