The Bowman Corporation has a bond obligation of $29 million outstanding, which i
ID: 1175386 • Letter: T
Question
The Bowman Corporation has a bond obligation of $29 million outstanding, which it is considering refunding. Though the bonds were initially issued at 13 percent, the interest rates on similar issues have declined to 11.9 percent. The bonds were originally issued for 20 years and have 10 years remaining. The new issue would be for 10 years. There is a call premium of 9 percent on the old issue. The underwriting cost on the new $29,000,000 issue is $590,000, and the underwriting cost on the old issue was $480,000. The company is in a 35 percent tax bracket, and it will use an 8 percent discount rate (rounded aftertax cost of debt) to analyze the refunding decision. Use Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods.
a. Calculate the present value of total outflows.(Do not round intermediate calculations and round your answer to 2 decimal places.)
b. Calculate the present value of total inflows.(Do not round intermediate calculations and round your answer to 2 decimal places.)
c. 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.)
d. Should the old issue be refunded with new debt?
Explanation / Answer
Where:
Payment of call premium= 29,000,000* 9% *(1-.35)= $1696500
Underwriting cost of new issue= Actual expenses- PV of future tax savings
Underwriting cost of new issue=$590000 – PV for 10 years at 8% of [590000/10 * .35]
Underwriting cost of new issue=$590000 – PV for 10 years at 8% of 20650
Underwriting cost of new issue=$590000 – 6.71*20650
Underwriting cost of new issue=$590000 –138561= $451439
Present value of total outflows= $1696500 + $451439= $2147939
Cost savings= PV for 10 years at 8% of After tax savings
Cost savings=6.71 * After tax savings
Cost savings= 6.71 *[ Interest on old bonds- interest on new bonds * (1-.35)]
Cost savings= 6.71 *[ (13%- 11.9%) * 29000000 * (1-.35)]
Cost savings= 6.71 *[ 1.1% *29000000*.65]
Cost savings= 6.71 *[207350]
Cost savings= 1391318
Underwriting cost of old issue= $480000- Amount written off for 10 years i.e. 240000 which is 24000 per year - PV of deferred future write off i.e. $24000*6.71
Underwriting cost of old issue=($480000- $240000 – 161040)* Tax at 35%
Underwriting cost of old issue=78960*35%= $27636
Present value of total inflows= $1391318+$27636= $1418954
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