15. The Shawn-Mathers Corporation has a $19 million bond obligation outstanding,
ID: 2805456 • Letter: 1
Question
15. The Shawn-Mathers Corporation has a $19 million bond obligation outstanding, which it is considering refunding. Though the bonds were initially issued at 10 percent, the interest rates on similar issues have declined to 6.5%. The bonds were originally issued for 20 years and have 10 years remaining. The new issue would be tor 10 years. There is an 8% call premium on the old issue. The underwriting cost on the new $19,000,000 issue is $575,000, and the underwriting cost on the old issue was $400,000. The company is in a 35 percent tax bracket, and it will use a 7% discount rate (rounded after-tax cost of debt) to analyze the refunding decision. a. Calculate the present value of total outflows (3pts) b. Calculate the present value of total inflows (3pts). c. Calculate the net present value (3pts). d. Should the old issue be refunded with new debt (3pts)?Explanation / Answer
a) outflow
call premium = 8%*19000000 = 1520000
After tax value = (1-35%)* 1520000= 988000
Underwriting costs = (575000 / 10) * 35% = 20125
PV of tax savings for next 10 years at 7%
PV = 20125*(1-(1+7%)-10)/7% = 141349.58
NPV = 575000 -141349.58 = 433650.42
Total outflows = 988000+ 433650.42 = 1421650.42
b)
Inflows
Interest on old bonds = 10%*19000000 = 1900000
Interest on new bonds = 6.5%*19000000 = 1235000
Savings = 1900000 - 1235000 = 665000
After tax savings = (1-35%)*665000 = 432250
PV of savings at 7% for 10 years = 432250*(1-(1+7%)-10)/7% = 3035943.12
Underwriting cost on old issue
Original amount = 400000
Amortization per year = 400000/20 = 20000
Amount written over 10 years = 10*(20000) = 200000
Remaining unamortized amount = 400000 - 200000 = 200000
PV of remaining 10 payments = 20000*(1-(1+7%)-10)/7% = 140471.63
Gain = 200000 -140471.63 = 59528.37
After tax gain = (1-35%)*(59528.37) = 38693.44
Total Inflows = 3035943.12 + 38693.44 = 3074636.56
c)
NPV = Inflows - outflows = 3074636.56 - 1421650.42 = 1652986.14
d)
Yes, As NPV is poistive
SHould be refunded with new debt
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