XYZ Company is in awe at the recent change in interest rates. The current intere
ID: 2665080 • Letter: X
Question
XYZ Company is in awe at the recent change in interest rates. The current interest rate on A2 rated bonds is currently at 6 percent. The $30 million, 15-year bond issue that the company has outstanding was initially issued at 9 percent five years ago.XYZ is considering refunding the bond issue due to this decline. The old issue had a call premium of 8 percent. The underwriting cost on the old issue had been 3 percent of par and on the new issue it would be 5 percent of par. The tax rate would be 30 percent and a 4 percent discount rate would be applied for the refunding decision. The new bond would have a 10-year life.
A. Compute the price of the old bonds in the open market using annual analysis. Determine the price for a single $1,000 par value bond.
B. Compare the price in part A to the 8 percent call premium over par value. Which appears to be more attractive in terms of reacquiring the old bonds?
Explanation / Answer
a. Price of Old Bond
Present Value of Interest Payments
PVA = A x PVIFA (n = 10, i = 8%)
PVA = $100 x 6.710 = $738.10
Present Value of Principal Payment at Maturity
PV = FV x PV (n = 10, i = 8%)
PV = $1,000 x .463 = $463
Total Present Value
Present Value of Interest Payments $738.10
Present Value of Principal Payment $463.00
Total Present Value or Price of Bond $1201.10
b.The price of $1,201.10 is more than 20 percent over par. The Call price is only 10 percent over par. Clearly, calling in the bonds is more attractive than repurchasing them in the open market.
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.