Interest rates have fallen since your company issued 20 year 9% coupon bonds six

Question

Interest rates have fallen since your company issued 20 year 9% coupon bonds six years ago to raise 12000000 of needed capital. Those bonds are now callable at the current market price and you are considering exercising the call provision.

Q1: If you wish to reduce your interest expense by calling the bonds, how much will you need to pay for each bond if bonds of similar risk to yours are yielding 5% in the market today?

Q2:Assume you purchased all the outstanding bonds at the price determined in part 1 above. You are considering retiring the debt with an issue of preferred stock which would require a 6% rate of return to attract investors. If you issued preferred shares at $100 par, how many preferred shares would you need to issue to cover the repurchase of the 9% coupon bonds from part 1 above?

Q3:If instead of issuing the preferred share from part 2, you simply replaced the 9% bonds with new 5% bonds, what would be the annual savings in interest cost for your company?

Explanation / Answer

Assume the $12 M bonds were issued at par Q1 Bond Details Par value         12,000,000 Annual Coupon @9% =         1,080,000 Years to maturity                          14 Current Market Yield = 5% Current Bond Price   Year Interest +Maturity PV factor @5% PV of Cash flows Year 1         1,080,000          0.952       1,028,571.4 Year 2         1,080,000          0.907           979,591.8 Year 3         1,080,000          0.864           932,944.6 Year 4         1,080,000          0.823           888,518.7 Year 5         1,080,000          0.784           846,208.3 Year 6         1,080,000          0.746           805,912.6 Year 7         1,080,000          0.711           767,535.8 Year 8         1,080,000          0.677           730,986.5 Year 9         1,080,000          0.645           696,177.6 Year 10         1,080,000          0.614           663,026.3 Year 11         1,080,000          0.585           631,453.6 Year 12         1,080,000          0.557           601,384.4 Year 13         1,080,000          0.530           572,747.1 Year 14       13,080,000          0.505       6,606,288.8 Total     16,751,347.7 Current Bond Price = $   16,751,348 Q2 Planned Price of preferred share                       100 Bond repurchase price=       16,751,348 Tital Preferred shares to be issued=             167,513 nos Q3 If current bond replaced with 5% bond, Interest cost on current 9% bond =         1,080,000 per year if 5% nods issued , then Bonds would be at Par   Assumed new $12 M bonds issued at Par as it is not mentioned what would be par value of new bonds: Annual interest @5% on $12 M Bonds=             600,000 per year Annual Interest saved =             480,000 If the Bonds issued for the repurchased price; Bond reissued at Par =       16,751,348 Annual Ineterst @5%=             837,567 In this case annual ineterst saved =             242,433

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