Suppose your company needs to raise $49 million and you want to issue 25-year bo
ID: 2738077 • Letter: S
Question
Suppose your company needs to raise $49 million and you want to issue 25-year bonds for this purpose. Assume the required return on your bond issue will be 7 percent, and you’re evaluating two issue alternatives: A semiannual coupon bond with a coupon rate of 7 percent and a zero coupon bond. Your company’s tax rate is 30 percent. Both bonds will have a par value of $1,000. a-1. How many of the coupon bonds would you need to issue to raise the $49 million? a-2 How many of the zeroes would you need to issue?(Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) b-1. In 25 years, what will your company’s repayment be if you issue the coupon bonds?(Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, i.e. 1,234,567.) b-2. What if you issue the zeroes? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, i.e. 1,234,567.) c. Calculate the aftertax cash flows for the first year for each bond.(Do not round intermediate calculations and enter your answers in dollars, not millions of dollars, i.e. 1,234,567.)
Explanation / Answer
A)
a-1) Bonds 7%
Market interest rate = 7% = required return
Coupon rate = 7%
Bond issue = par value = $1000
Bonds need to issue = $49,000,000 / $1000 = 49000
a-2) Zeros
FV = future value = $1000
i = interest rate = 7%
t = number of complete years = 25 years
FV = PV * (1 + i)^t
$1000 = PV * (1+ 0.07)^25
PV = 184.25
Bonds = 49000000 / 184.25 = 265943
B)
B-1) Bonds 7%
Coupon repayment amount (C) maturity in 25 years
FV = $49000000
= $ 3430000 PMT of int [(0.07)* 49000000]
===$ 52430000 repaid
B-2) Zeros
= 26543 bonds * $1000
= 26543000
C)
Coupon bonds
Interest Expense per year = $3430000
After tax effect = (1- 0.30)
After tax cash outflow = 2401000
Zeros
At year=0
At year=1
Where
FV = future value = $1000
i = interest rate = 7%
t = number of complete years = 25 years
FV = PV * (1 + i)^t
$1000 = PV * (1+ 0.07)^25
PV = 184.25
Where
FV = future value = $1000
i = interest rate = 7%
t = number of complete years = 24 years
FV = PV * (1 + i)^t
$1000 = PV * (1+ 0.07)^24
PV = 197.15
PV = 184.25
PV = 197.15
Interest = (197.15 – 184.25)
= 12.9
Cash flow = 12.9 * 26543 bonds * (.30) = 102721
At year=0
At year=1
Where
FV = future value = $1000
i = interest rate = 7%
t = number of complete years = 25 years
FV = PV * (1 + i)^t
$1000 = PV * (1+ 0.07)^25
PV = 184.25
Where
FV = future value = $1000
i = interest rate = 7%
t = number of complete years = 24 years
FV = PV * (1 + i)^t
$1000 = PV * (1+ 0.07)^24
PV = 197.15
PV = 184.25
PV = 197.15
Interest = (197.15 – 184.25)
= 12.9
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