EXCEL TEMPLATE ) Watchstone Concrete Products issued 30-year maturity bonds 15 y

Question

EXCEL TEMPLATE) Watchstone Concrete Products issued 30-year maturity bonds 15 years ago with a coupon rate of 10.75%. The principal amount was $15,000,000. Interest rates have steadily decreased and the company could issue new bonds today at a coupon rate of 9.50%. The new issue would be used to pay off the old bonds and would have a maturity of 15 years. The original issue had flotation costs of $375,000 which were set up on an amortization schedule over 30 years with equal amounts each year. The old bonds are callable with a premium of 4.5%. An investment banking firm would charge a flotation fee of $225,000 on the new issue that would be amortized over the life of the new bonds. Rover’s marginal tax rate is 25%. Calculate the NPV of the bond refund

a.Old and nwe Bond Principal?

b.Old and new Bond Interest Rate?

c.Old and new Bond Flotation Cost?

d.Old and new Bond Maturity (Years)?

e.Tax Rate?

f.Call Premium Rate?

Explanation / Answer

Step 1: Incremental Initial flow

Sum (684,375)

Step 2: Incremental inbetween flows

sum 141,250

Step 3: Incremental terminal flow

Sum 0

Step 4: Calculation of NPV

In the absence of discount rate being given, the coupon rate associated with new bond is the pre tax discount rate. So post tax discount rate=9.5%(no tax here)

NPV = PV of Inflows - PV of outflows

= 1105733.25-684375

= 421358.25

Decision: Since the NPV is positive, refund the bonds.

Raise the fund 15,000,000 Repay the old bond      (15,000,000) Floatation cost on new bond (225,000) Call Premium (15,000,000*4.5%) (675,000) Tax saved on call premium (675,000*25%) 168,750 Tax saved on unamortised portion of floatation cost of old bond (WN 1) 46,875

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