Suppose your company needs to raise $49 million and you want to issue 25-year bo

Question

Suppose your company needs to raise $49 million and you want to issue 25-year bonds for this purpose. Assume the required return on your bond issue will be 7 percent, and you’re evaluating two issue alternatives: A semiannual coupon bond with a coupon rate of 7 percent and a zero coupon bond. Your company’s tax rate is 30 percent. Both bonds will have a par value of $1,000. a-1. How many of the coupon bonds would you need to issue to raise the $49 million? a-2 How many of the zeroes would you need to issue? b-1. In 25 years, what will your company’s repayment be if you issue the coupon bonds? b-2. What if you issue the zeroes? c. Calculate the aftertax cash flows for the first year for each bond.

Explanation / Answer

Answer:a-1 The coupon bonds have a 7 percent coupon which matches the 7 percent required return, so they will sell at par. The number of bonds that must be sold is the amount needed divided by the bond price, so:

Number of coupon bonds to sell = $49,000,000 / $1,000 = 49,000

Answer:a-2 The number of zero coupon bonds to sell would be:

Price of zero coupon bonds = $1,000/(1.07)25= $184.249

Number of zero coupon bonds to sell = $49,000,000 / $184.249 = 265,944.46

Answee:b-1 The repayment of the coupon bond will be the par value plus the last coupon payment times the number of bonds issued. So:

Coupon bonds repayment = 49,000($1,070) = $52,430,000

Answer:b-2 The repayment of the zero coupon bond will be the par value times the number of bonds issued,so:

Zeroes: repayment =265,944.46 ($1,000) = $265,944,460

Answer:c Coupon bonds=49000

Interest paid last year= 70

Per year interest expense=3430000 (49000*70)

After tax effect=(1-0.30)

After tax cash flow=3430000*0.70=2401000

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