The Robinson Corporation has $61 million of bonds outstanding that were issued a

Question

The Robinson Corporation has $61 million of bonds outstanding that were issued at a coupon rate of 10 3/4 percent seven years ago. Interest rates have fallen to 9 3/4 percent. Mr. Brooks, the vice-president of finance, does not expect rates to fall any further. The bonds have 16 years left to maturity, and Mr. Brooks would like to refund the bonds with a new issue of equal amount also having 16 years to maturity. The Robinson Corporation has a tax rate of 30 percent. The underwriting cost on the old issue was 2.3 percent of the total bond value. The underwriting cost on the new issue will be 1.6 percent of the total bond value. The original bond indenture contained a five-year protection against a call, with a 8.5 percent call premium 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). Assume the discount rate is equal to the aftertax cost of new debt rounded to the nearest whole number. Use Appendix D.

Compute the discount rate. (Round your answer to the nearest whole percent. Omit the "%" sign in your response.)

Calculate the present value of total outflows.(Round "PV Factor" to 3 decimal places, intermediate and final answer to the nearest dollar amount. Omit the "$" sign in your response.)

Calculate the present value of total inflows. (Round "PV Factor" to 3 decimal places, intermediate and final answer to the nearest dollar amount. Negative amount should be indicated by a minus sign. Omit the "$" sign in your response.)

Calculate the net present value. (Round "PV Factor" to 3 decimal places, intermediate and final answer to the nearest dollar amount. Negative amount should be indicated by a minus sign. Omit the "%" sign in your response.)

The Robinson Corporation has $61 million of bonds outstanding that were issued at a coupon rate of 10 3/4 percent seven years ago. Interest rates have fallen to 9 3/4 percent. Mr. Brooks, the vice-president of finance, does not expect rates to fall any further. The bonds have 16 years left to maturity, and Mr. Brooks would like to refund the bonds with a new issue of equal amount also having 16 years to maturity. The Robinson Corporation has a tax rate of 30 percent. The underwriting cost on the old issue was 2.3 percent of the total bond value. The underwriting cost on the new issue will be 1.6 percent of the total bond value. The original bond indenture contained a five-year protection against a call, with a 8.5 percent call premium 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). Assume the discount rate is equal to the aftertax cost of new debt rounded to the nearest whole number. Use Appendix D.

Explanation / Answer

1) Since you're not given a tax rate I assume the tax benefit of depreciation is already taken into account?

PV of the $4,000 savings for 10 years...
use: PVoa = PMT [(1 - (1 / (1 + i)^n)) / i]
= 4000[((1 - (1/1.12^10)) / 0.12]
= 4000[5.65022]
= 22,600.89
subtract initial outflow of 25,000 ...
NPV = (2,399.11) <negative #

2) undiscounted cash inflows: 4,000 * 10 = 40,000
outflow: 25,000
40,000 - 25,000 = $15,000

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