Suppose your company needs to raise $53 million and you want to issue 20-year bo

Question

Suppose your company needs to raise $53 million and you want to issue 20-year bonds for this purpose. Assume the required return on your bond issue will be 8 percent, and you're evaluating two issue alternatives: A semiannual coupon bond with a coupon rate of 8 percent and a zero coupon bond. Your company's tax rate is 40 percent. Both bonds will have a par value of $1,000. How many of the coupon bonds would you need to issue to raise the $53 million? 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.) In 20 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.) 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.) Calculate the after tax 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

Answer A-1 )

Considering one bond with a face value of $ 1000

As the required rate of return on bond = coupon rate

Bonds are valued at par

So , the number of bonds = 53,000,000 / 1000 = 53,000

Answer a-2 )

for Zero coupond bonds

N=20 * 2 = 40

I/Y = 8 / 2 = 4 %

PMT = 0

FV = 1000

So, from the formula , PV = $ 208.29

So the number of zero coupon bonds = 53,000,000 / 208.29 = 254,454.09

Answer b-1 )

For coupon bonds, Company pay each half of the year the coupon = 40 * 53000 = $ 2,120,000

So the coupon paid for 20 years = 40 * 2,120,000 = 84,800,000

And then the principle repayment is done in 20th year = 53,000,000

Answer b-2 )

Repayment for Zero coupon bonds = Number of bonds * 1000     ( As there is no coupon so this is principle repayment)

                                                        = 254,454.09 * 1000

                                                        = $ 254,454,090

Answer C )

After First year , Coupon bond Cash Outflow = 2,120,000 * 2 = $ 4,240,000

This is an interest payment by company so company must receive tax benefit towards this.

Cash Inflow due to tax = 4,240,000 * 0.4 = 1,696,000

Effective cash outflow after considering tax benefits = 4,240,000 - 1,696,000 = $ 2,544,000

For zero coupon bonds company will not pay any coupons during any of the years

So the cash ouflow / Inflow = 0

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