The Bowman Corporation has a $18 million bond obligation outstanding, which it i
ID: 2644819 • Letter: T
Question
The Bowman Corporation has a $18 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 8.5 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 9 percent call premium on the old issue. The underwriting cost on the new $18,000,000 issue is $530,000, and the underwriting cost on the old issue was $380,000. 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.
a. Calculate the present value of total outflows.
b. Calculate the present value of total inflows.
c. Calculate the net present value.
d. Should the old issue be refunded with new debt?
Explanation / Answer
a. Calculate the present value of total outflows.
Call Premium = 9%*18000000 = 1620000
Underwriting cost = 530000
Present value of total outflows = 2150000
b. Calculate the present value of total inflows.
Old Underwriting cost balance available in books not w/off = 380000*10/20 = 190000
Annual Saving in Post tax interest = 18000000*(10-8.5)%*(1-35%) = 175500
Tax saving on old Underwriting cost balance = 190000*35% = 66500
Increase in Annual Underwriter cost to be w/off = (530000/10 - 380000/20) = 34000
Annual Tax saving on Increase in Annual Underwriter cost = 34000*35% = 11900
Annual total Saving = 175500 + 11900 = 187400
Present value of total inflows = 66500/1.08 + 187400/1.08 + 187400/1.08^2 + 187400/1.08^3+ 187400/1.08^4+ 187400/1.08^5+ 187400/1.08^6+ 187400/1.08^7+ 187400/1.08^8+ 187400/1.08^9+ 187400/1.08^10
Present value of total inflows = $ 1,319,043.33
c. Calculate the net present value.
Net present value =- 2150000 + 1319043.33
Net present value = - $ 830,596.67
d. Should the old issue be refunded with new debt?
No , The old issue should not be refunded with new debt
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.