The Robinson Corporation has $41 million of bonds outstanding that were issued a

Question

The Robinson Corporation has $41 million of bonds outstanding that were issued at a coupon rate of 9 3/4 percent seven years ago. Interest rates have fallen to 8 3/4 percent. Mr. Brooks, the vice-president of finance, does not expect rates to fall any further. The bonds have 15 years left to maturity, and Mr. Brooks would like to refund the bonds with a new issue of equal amount also having 15 years to maturity. The Robinson Corporation has a tax rate of 35 percent. The underwriting cost on the old issue was 2.2 percent of the total bond value. The underwriting cost on the new issue will be 1.5 percent of the total bond value. The original bond indenture contained a five-year protection against a call, with a 8 percent call premium starting in the sixth year and scheduled to decline by one-half percent each year thereafter. (Consider the bond to be 7 years old for purposes of computing the premium). Assume the discount rate is equal to the aftertax cost of new debt rounded to the nearest whole number.

What would be the aftertax cost of the call premium at the end of year 10 (in dollar value)? (Omit the "$" sign in your response.)

The Robinson Corporation has $41 million of bonds outstanding that were issued at a coupon rate of 9 3/4 percent seven years ago. Interest rates have fallen to 8 3/4 percent. Mr. Brooks, the vice-president of finance, does not expect rates to fall any further. The bonds have 15 years left to maturity, and Mr. Brooks would like to refund the bonds with a new issue of equal amount also having 15 years to maturity. The Robinson Corporation has a tax rate of 35 percent. The underwriting cost on the old issue was 2.2 percent of the total bond value. The underwriting cost on the new issue will be 1.5 percent of the total bond value. The original bond indenture contained a five-year protection against a call, with a 8 percent call premium starting in the sixth year and scheduled to decline by one-half percent each year thereafter. (Consider the bond to be 7 years old for purposes of computing the premium). Assume the discount rate is equal to the aftertax cost of new debt rounded to the nearest whole number.

Explanation / Answer

Use the following procedure it may help you out :

1)Determine the coupon rate of the bond

2)Divide the annual interest amount by the number of times interest is paid per year, to arrive at I

3)Determine the minimum rate of return required, or discount rate

4)Determine the number of periods interest is paid, n, by multiplying the number of years till maturity by the number of times interest is paid

5)Plug in I, k and n into the present value annuity formula PVA = I[1-(1+k)^-n]/k to arrive at the present value of interest payments

6)Plug in k and n into the present value formula PV = FV/(1+k)^n to arrive at the present value of the principal of the bond (FV)

7)Add the present value of interest to the present value of principal, to arrive at the present bond value

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