The Bowman Corporation has a bond obligation of $23 million outstanding, which i
ID: 2744757 • Letter: T
Question
The Bowman Corporation has a bond obligation of $23 million outstanding, which it is considering refunding. Though the bonds were initially issued at 12 percent, the interest rates on similar issues have declined to 10.7 percent. The bonds were originally issued for 20 years and have 10 years remaining. The new issue would be for 10 years. There is a call premium of 8 percent on the old issue. The underwriting cost on the new $23,000,000 issue is $530,000, and the underwriting cost on the old issue was $420,000. The company is in a 35 percent tax bracket, and it will use an 12 percent discount rate (rounded aftertax cost of debt) to analyze the refunding decision. Calculate your final answer using the formula and financial calculator methods.
a.
Calculate the present value of total outflows. (Do not round intermediate calculations and round your answer to 2 decimal places.)
PV of total outflows
$
b.
Calculate the present value of total inflows. (Do not round intermediate calculations and round your answer to 2 decimal places.)
PV of total inflows
$
c.
Calculate the net present value. (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places.)
Net present value
$
d.
Should the old issue be refunded with new debt?
Yes
No
The Bowman Corporation has a bond obligation of $23 million outstanding, which it is considering refunding. Though the bonds were initially issued at 12 percent, the interest rates on similar issues have declined to 10.7 percent. The bonds were originally issued for 20 years and have 10 years remaining. The new issue would be for 10 years. There is a call premium of 8 percent on the old issue. The underwriting cost on the new $23,000,000 issue is $530,000, and the underwriting cost on the old issue was $420,000. The company is in a 35 percent tax bracket, and it will use an 12 percent discount rate (rounded aftertax cost of debt) to analyze the refunding decision. Calculate your final answer using the formula and financial calculator methods.
Explanation / Answer
Given values,
Original tenor of the old bond= 20 years
Remaining life of the old bond= 10 years
Tenor of the new bond= 10 years
Discount rate= 12%
Amount of bond= $23,000,000
Old Interest rate= 12.00%
New Interest Rate= 10.70%
Call premium= 8%
Underwriting Cost on old issue= $420,000
Underwriting Cost on new issue= $530,000
Tax rate= 35%
a)
CASHOUTFLOW
After tax cost of call premium = 8% x $23,000,000. x (1 - 35%)
= $1,196,000
Underwriting cost for new issue:
Total underwriting cost= $530,000
Number of years= 10 years
Expense (for tax purpose) underwriting cost= $530,000 / 10 = $53,000
Tax shield from underwriting expense= 35% x $53,000 = $18550
Present Value of Tax shield of underwriting expense:
n= 5
r= 6.00%
Annuity= $18500 (as calculated above)
Therefore, pre5ent value = PV(12%, 10 years, $18550)
= $104811.63 (Excel formula for present value used)
Therefore, net after tax underwriting cost= $530,000. - $104811.63
= $425188.37
PV of Total Outflow = $425188.37 + $1,196,000
= - 1621188.37
b)
CASHINFLOW:
n= 5 years
r= 6.00%
After tax saving in interest,
PV of Cash cost saving less tax benefits = $23,000,000.x (12% - 10.7% ) x (1 - 35%) x PVIFA (12%, 10 years)
= $23,000,000.x 1.3% x 65% * 5.65022
= $1098120.257
c)
Net present value
Net Present value = - $1621188.37 + $1098120.257
= - $523035.113
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