Suppose your company needs to raise S36.1 million and you want to issue 21-year
ID: 2757754 • Letter: S
Question
Suppose your company needs to raise S36.1 million and you want to issue 21-year bonds for this purpose. Assume the required return on your bond issue will be 8.6 percent, and you're evaluating two issue alternatives: a 8.6 percent semiannual coupon bond and a zero coupon bond. Your company's tax rate is 35 percent. How many of the coupon bonds would you need to issue to raise the S36.1 million? (Do not round intermediate calculations. Enter the whole number for your answer, not millions (e.g., 1,234,567).) How many of the zeroes would you need to issue? {Do not round intermediate calculations. Enter the whole number for your answer, not millions (e.g., 1,234,567). Round your answer to 2 decimal places (e.g., 32.16).) In 21 years, what will your company's repayment be if you issue the coupon bonds? (Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars (e.g., 1,234,567).) What if you issue the zeroes? (Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars (e.g., 1,234,567). Round your answer to the nearest whole dollar amount (e.g., 32).) Assume that the IRS amortization rules apply for the zero coupon bonds. Calculate the firm's after-tax cash outflows for the first year under the two different scenarios. (Do not round intermediate calculations. Input a cash outflow as a negative value and a cash inflow as a positive value. Enter your answers in dollars, not millions of dollars (e.g., 1,234,567). Round your answers to 2 decimal places (e.g., 32.16).)Explanation / Answer
Req 1:
a After tax yield = 8.6*(1-0.35) = 5.59% = 0.0599. The price of the bond =pv(rate,nper,pmt,fv) =pv(0.0559/2,21*2, 43,1000) = $1,369.29
No. of bonds = 36,100,000/1,369.29 = 26,364.02 =26,365 bonds
b. Price of zero coupon bond = FV/(1+r)^n = 1000/1.02795^42 = $314.1784
No. of zeros = 36,100,000/314.1784 = 114,902.85 = 114,903 bonds
Req 2:
Repayment = Interest payment + princpal = 43*42 + 1000 = 2,806 for one bond. So for all bonds repayment = 26,365 * 2,806 = $73,980,190
Repayment for zeros = principal 114,903 = $114,903,000
Req 3: After tax cash flows for Coupon bond in year 1 = 43 *2 = $86 .
For zero coupon bond:
Book value at the time of issue = 314.1784
At the end of the first year, the interest payable will be 0.086*314.1784 = 27.0193.
So the value at the end of the first year = 314.1784+ 27.0193 = $341.1977 = 341.20
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