Suppose your company needs to raise $35.3 million and you want to issue 23-year
ID: 2772571 • Letter: S
Question
Suppose your company needs to raise $35.3 million and you want to issue 23-year bonds for this purpose. Assume the required return on your bond issue will be 7.8 percent, and you’re evaluating two issue alternatives: a 7.8 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 $35.3 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 23 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 aftertax 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).)
Suppose your company needs to raise $35.3 million and you want to issue 23-year bonds for this purpose. Assume the required return on your bond issue will be 7.8 percent, and you’re evaluating two issue alternatives: a 7.8 percent semiannual coupon bond and a zero coupon bond. Your company’s tax rate is 35 percent.
Explanation / Answer
Given
Amount to be Raised = $ 35.3 Million
Time to Maturity = 23 years
Rate of Return = 7.8% Semi-annual coupon
Assuming face value of coupon / zero coupon bond = $ 1000
Requirement 1
Answer (a)
No. of Coupon Bonds to be issued to raise $ 35.3 Million = $ 35,300,000/$ 1000 = 35,300
Answer (b)
Price at which Zero Coupon Bond to be issued = $1000/(1+0.078)^23 = $ 1000 / 1.078^23
= $1000/5.62641 = $ 177.73
Number of Zero Coupon Bonds to be issued to raise $ 35.3 Million = $ 35,300,000 / $ 177.73
= 198615.87
Therefore Number of Zero Coupon Bonds to be issued to raised $ 35.3 Million is 198,616.
Requirement 2
Answer (a)
Semi-Annual Coupon Bond
Total Number of Bonds Issued = 35300
Semi Annual Coupon Payment = 1000 * 7.8% * 0.5 = $ 39
Total coupon payment period = 23 * 2 = 46
Total Coupon Payment = No of Bonds * Semi Annual Coupon * Total Coupon payment period
= 35300 * $ 39 *46 = $ 63,328,200
Total Principal to be repaid at the end of time period = $ 35,300,000
Total Repayment on account of the Loan = $ 63,328,200 + $ 35,300,000 = $ 98,628,200
Answer (b)
Zero Coupon Bond
Total Number of Bonds Issued = 198616
Total amount payable after 23 years = 198616 * $ 1000 = $ 198,616,000
Requirement 3
Coupon Bond Cash Flow = $ 1,789,710
Zero Coupon Bond Cash Flow = $ $ 1,790,622.55
7.8% Semi Annual Coupon Bond
Total Interest paid for first year = 35300 * $ 39 * 2 = $ 2,753,400
Tax Rate = 35%
After Tax Cash Flow = $ 2,753,400 * (1-Tax Rate) = $2,753,400 * (1-0.35) = $ 1,789,710
Zero Coupon Bonds
Value at Bonds were Issued = $ 177.73
Present Value 1 year after issue = $1000/1.078^22 = $ 1000 / 5.21931 = $ 191.596 or $ 191.60
As per IRC amortization rules
Accrued Interest = No of Bonds issued * (Price end of 1 year – Issue Price)
= 198616 * (191.60 – 177.73)
= 198616 * $ 13.87 = $ 2,754,803.92
After Tax cash flow = $ 2,754,803.92 * (1-0.35) = $ 1,790,622.55
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