The Robinson Corporation has $28 million of bonds outstanding that were issued a
ID: 2469420 • Letter: T
Question
The Robinson Corporation has $28 million of bonds outstanding that were issued at a coupon rate of 11.050 percent seven years ago. Interest rates have fallen to 10.550 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 2.80 percent of the total bond value. The underwriting cost on the new issue will be 1.90 percent of the total bond value. The original bond indenture contained a five-year protection against a call, with a call premium of 6 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).
Compute the discount rate. (Do not round intermediate calculations. Input your answer as a percent rounded up to the nearest whole percent.)
Calculate the present value of total outflows. (Do not round intermediate calculations and round your answer to 2 decimal places.)
Calculate the present value of total inflows. (Do not round intermediate calculations and round your answer to 2 decimal places.)
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 $28 million of bonds outstanding that were issued at a coupon rate of 11.050 percent seven years ago. Interest rates have fallen to 10.550 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 2.80 percent of the total bond value. The underwriting cost on the new issue will be 1.90 percent of the total bond value. The original bond indenture contained a five-year protection against a call, with a call premium of 6 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).
Explanation / Answer
First compute the discount rate
10.55% (1 – .30) = 10.55% × .70 = 7.385%. Round up to 7%
Calculate the present value of total outflows
1. Payment on call provision
$28,000,000*5.5% = $1,540,000
$1,540,000*(1-.30) = $1,078,000
2. Underwriting cost on new issue
Actula expensiturte = 1.90%*28,000,000 = $532,000
Amortization of costs ($532,000/18)*.30 = $13,300
Actual expenditure = $532,000
PV of future tax savings $13,300*9.7362 = $131,180.56
Net cost of underwriting expense on new issue = $400,819.44
*PVIFA fro n = 17 , i = 7%
Calculate the present value of total inflows
Cost savings in lower interest rates
11.050%(int. on old bonds)*28,000,000 = $3,094,000
Less: 10.55% (int. on new bond)*$28,000,000 = $2,954,000
Savings per year = $140,000
Savings per year $140,00*(1-0.300 = $98,000
Aftertax
$98,000*9.7362 = $956,793.60 = Present value of savings
4. Underwriting cost on onld issue
Original amount (2.8%*28,000,000) = $784,000
Amount written off over last 7 years at $32,667 per year ($784,000/24)*7 = $228,667
Unamortized old underwriting cost = $555,333
Present value of deferred future write off:
$32,667*9.7632(n=17,i =7%) $318,9321
Immediate gain in old underwriting write-off = $236,402
Tax rate = 0.30
Aftertax value of immediate gain in old underwriying cost write-off $70,920.64.
Based on the negative net present value, the Robinson Corporation should not refund the issue
Outflows Inflows 1,078,000 956,793.60 400,819.44 70920.64 1,478,819 1,027,714.24Related Questions
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