Problem 20-6 Please I asking you very kindly to help me with this problem you do

Question

Problem 20-6

Please I asking you very kindly to help me with this problem you do not have to use the build model for excel.   I just would like you you help because I am having a very difficult time with the calculations. Please.           

                              

Schumman Shoe Manufacturer is considering whether or not to refund a $70 million, 10% coupon, 30-year bond issue that was sold years ago. Its amortizing $4.5 million floatation costs on the 10% bond over the issue's 30-year life. Shaumman's investment bankers have indicated that the companycould sell a new 22-year issue at an interest rate of 8% in today's market . Neither they or Schumann's management anticipate that interest rate will fall below 6 percent anytime soon, but there is a chance that interest rates will increase.            

A. Perform a complete bond refunding analysis. What is the bond refunding's NPV?

B. At what interest rate on the new debt is the NPV of the refunding no longer positive?

Thanks in advance.

Explanation / Answer

Hi,

Please find the answer as follows:

Part A:

Initial investment outlay to refund old issue:
Call premium on old issue =
$ 70,00,000.00 After-tax call premium =
$ 42,00,000.00 New flotation cost =
$ 50,00,000.00 Old flotation costs already expensed = $ 12,00,000.00 Remaining flotation costs to expense = $ 33,00,000.00 Tax savings from old flotation costs = $ 13,20,000.00 Additional interest on old issue after tax = $ 3,50,000.00 Interest earned on investment in T-bonds after tax = $ 1,75,000.00 Total investment outlay =
$ 80,55,000.00



Annual Flotation Cost Tax Effects:
Annual tax savings on new flotation = $ 90,909.09 Tax savings lost on old flotation = $ 60,000.00 Total amortization tax effects =
$ 30,909.09



Annual interest savings due to refunding:
Annual after tax interest on old bond = $ 42,00,000.00 Annual after tax interest on new bond = $ 33,60,000.00 Net after tax interest savings =
$ 8,40,000.00



Annual cash flows =
$ 8,70,909.09



NPV of refunding decision =
$ 34,08,778.61

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