The Bowman Corporation has a bond obligation of $15 million outstanding, which i

Question

The Bowman Corporation has a bond obligation of $15 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 10.8 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 $15,000,000 issue is $450,000, and the underwriting cost on the old issue was $340,000. The company is in a 35 percent tax bracket, and it will use an 11 percent discount rate (rounded aftertax cost of debt) to analyze the refunding decision. Use Appendix D for an approximate answer but 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 $

Explanation / Answer

Outflows After tax cost of call $780,000 Underwriting cost on new issue Actual expenditure $450,000 Amortization of Costs 45,000 Present value of future tax savings 110,628 45000*0.35*7.024 Net cost of underwriting expense $339,372 Inflows Cost savings in lower interest rates: Interest on old bonds $1,800,000 Interest on new bonds $1,620,000 Savings per year before taxes $180,000 Aftertax Savings per year $117,000 Present value of savings $821,808 Underwriting cost on old issue Original amount $340,000 Amount written off over 10 years $170,000 Unamortized old underwriting cost $170,000 Present value of deferred future write-off $119,408 Immediate gain in old underwriting cost write-off $50,592 After-tax value of immediate gain in old underwriting cost write-off $17,707 PV of Inflows $839,515 PV of Outflows $1,119,372 Net present value ($279,857) Should the old issue be refunded with new debt? No, the old issue should not be refunded with new debt.

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