The Robinson Corporation has $38 million of bonds outstanding that were issued a
ID: 2793589 • Letter: T
Question
The Robinson Corporation has $38 million of bonds outstanding that were issued at a coupon rate of 12.050 percent seven years ago. Interest rates have fallen to 11.050 percent. Mr. Brooks, the Vice-President of Finance, does not expect rates to fall any further. The bonds have 17 years left to maturity, and Mr. Brooks would like to refund the bonds with a new issue of equal amount also having 17 years to maturity. The Robinson Corporation has a tax rate of 30 percent. The underwriting cost on the old issue was 3.80 percent of the total bond value. The underwriting cost on the new issue will be 2.40 percent of the total bond value. The original bond indenture contained a five-year protection against a call, with a call premium of 8 percent starting in the sixth year and scheduled to decline by one-half percent each year thereafter. (Consider the bond to be seven years old for purposes of computing the premium.) Use Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods. Assume the discount rate is equal to the aftertax cost of new debt rounded up to the nearest whole percent (e.g. 4.06 percent should be rounded up to 5 percent) a. Compute the discount rate. (Do not round intermediate calculations. Input your answer as a percent rounded up to the nearest whole percent.) = 8%b. Calculate the present value of total outflows. (Do not round intermediate calculations and round your answer to 2 decimal places.)
c. Calculate the present value of total inflows. (Do not round intermediate calculations and round your answer to 2 decimal places.)
d. 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.)
The Robinson Corporation has $38 million of bonds outstanding that were issued at a coupon rate of 12.050 percent seven years ago. Interest rates have fallen to 11.050 percent. Mr. Brooks, the Vice-President of Finance, does not expect rates to fall any further. The bonds have 17 years left to maturity, and Mr. Brooks would like to refund the bonds with a new issue of equal amount also having 17 years to maturity. The Robinson Corporation has a tax rate of 30 percent. The underwriting cost on the old issue was 3.80 percent of the total bond value. The underwriting cost on the new issue will be 2.40 percent of the total bond value. The original bond indenture contained a five-year protection against a call, with a call premium of 8 percent starting in the sixth year and scheduled to decline by one-half percent each year thereafter. (Consider the bond to be seven years old for purposes of computing the premium.) Use Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods. Assume the discount rate is equal to the aftertax cost of new debt rounded up to the nearest whole percent (e.g. 4.06 percent should be rounded up to 5 percent) a. Compute the discount rate. (Do not round intermediate calculations. Input your answer as a percent rounded up to the nearest whole percent.) = 8%
b. Calculate the present value of total outflows. (Do not round intermediate calculations and round your answer to 2 decimal places.)
c. Calculate the present value of total inflows. (Do not round intermediate calculations and round your answer to 2 decimal places.)
d. 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.)
The Robinson Corporation has $38 million of bonds outstanding that were issued at a coupon rate of 12.050 percent seven years ago. Interest rates have fallen to 11.050 percent. Mr. Brooks, the Vice-President of Finance, does not expect rates to fall any further. The bonds have 17 years left to maturity, and Mr. Brooks would like to refund the bonds with a new issue of equal amount also having 17 years to maturity. The Robinson Corporation has a tax rate of 30 percent. The underwriting cost on the old issue was 3.80 percent of the total bond value. The underwriting cost on the new issue will be 2.40 percent of the total bond value. The original bond indenture contained a five-year protection against a call, with a call premium of 8 percent starting in the sixth year and scheduled to decline by one-half percent each year thereafter. (Consider the bond to be seven years old for purposes of computing the premium.) Use Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods. Assume the discount rate is equal to the aftertax cost of new debt rounded up to the nearest whole percent (e.g. 4.06 percent should be rounded up to 5 percent) a. Compute the discount rate. (Do not round intermediate calculations. Input your answer as a percent rounded up to the nearest whole percent.) = 8%
b. Calculate the present value of total outflows. (Do not round intermediate calculations and round your answer to 2 decimal places.)
c. Calculate the present value of total inflows. (Do not round intermediate calculations and round your answer to 2 decimal places.)
d. 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.)
The Robinson Corporation has $38 million of bonds outstanding that were issued at a coupon rate of 12.050 percent seven years ago. Interest rates have fallen to 11.050 percent. Mr. Brooks, the Vice-President of Finance, does not expect rates to fall any further. The bonds have 17 years left to maturity, and Mr. Brooks would like to refund the bonds with a new issue of equal amount also having 17 years to maturity. The Robinson Corporation has a tax rate of 30 percent. The underwriting cost on the old issue was 3.80 percent of the total bond value. The underwriting cost on the new issue will be 2.40 percent of the total bond value. The original bond indenture contained a five-year protection against a call, with a call premium of 8 percent starting in the sixth year and scheduled to decline by one-half percent each year thereafter. (Consider the bond to be seven years old for purposes of computing the premium.) Use Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods. Assume the discount rate is equal to the aftertax cost of new debt rounded up to the nearest whole percent (e.g. 4.06 percent should be rounded up to 5 percent) a. Compute the discount rate. (Do not round intermediate calculations. Input your answer as a percent rounded up to the nearest whole percent.) = 8%
b. Calculate the present value of total outflows. (Do not round intermediate calculations and round your answer to 2 decimal places.)
c. Calculate the present value of total inflows. (Do not round intermediate calculations and round your answer to 2 decimal places.)
d. 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.)
Explanation / Answer
a) discount rate = after tax cost of new debt
new debt rate =11.05% ,tax rate = 30%
hence post tax cost of debt = 11.05(100%-30%) =11.05*70%=7.735%~ rounded of to 8%
b) PV of the total outflows
and we are redeeming bond in 7th year hence applicable premium rate = 8%- 0.5% = 7.5%
premium on bond redemption= 38,000,000*7.5% = 2,850,000
tax shield on call premium = 2,850,000*30% = 855,000
after tax premium cost = 2,850,000 - 855,000 = 1,995,000
2. underwriting expense on new issue = 38,000,000 * 2.4% = 912,000.00
amortization cost per year =912000/17 = 53,647.06
tax saving on amortisation cost every year = 53647.06*30%= 16,094.11
PV of tax saving on amortisation cost for 17 years= 16094.11*PVIAF(8%,17) = 160.94.11*9.1216=146804.65
(underwritig expense are written off over the maturity of bond and is tax deductible expense, hence generates tax saving)
net cost of underwriting expense = 912000-146804.65 =765195.35
PV of total outflows = 1995000+765195.35=2760195.35
c) PV of total inflows
3. after tax interest on old bold = 38,000,000*12.05%*0.70(after tax rate) = 3,205,300
after tax interest onnew bond= 38,000,000*11.05%*0.70(after tax rate) = 2,939,300
Saving in interest per year = 3205300-2939300= 266000
Saving of interest in Upcoming 17 years = PV of saving of interest in 17 years = 266000*PVIAF(8%,17) =2426355.74
saving in interest = 2426355.74
4. underwrting cost on old issue = 38000000*3.8%=1444000
amout written off over last 7 years=1444000*7/24=421166.67(total life of old bond= 7year past+17 years left to mature=24
unamortized underwriting cost =1444000-421166.67=1022833.33
underwring cost on old bond per year = 1444000/24 = 60166.67
PV of deferred future write off = 60166.67PVIAF(8%,17)=548816.27
immediate gain in old undewriting expense = 1022833.33-548816.27=474017.06
explanation
(if we haven't issued new bond and continued with the old one then we w'd have got the benefit of 548816.27 on old bond
but since we are issuing the new bond hence leftover unamortized expense of old bond ie.1022833.33 will be write off at once in the year in which new bond is issued , hence additional benefit on new bond = (1022833.33-54816.27)*0.3
tax saving on immediate gain in old undw. exp.=474017.06*0.3= 142205.12
PV of total inflows = 2426355.74+142205.12=2568560.86
d) net present value
NPV = PV of inflows - PV of outflows
= 2568560.86-2760195.35
= -191634.50
hence bond refunding is not viable since it generates negative NPV.company should not refund bond now.
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