Suppose your company needs to raise $41 million and you want to issue 20-year bo
ID: 2738313 • Letter: S
Question
Suppose your company needs to raise $41 million and you want to issue 20-year bonds for this purpose. Assume the required return on your bond issue will be 8 percent, and you’re evaluating two issue alternatives: A semiannual coupon bond with a coupon rate of 8 percent and a zero coupon bond. Your company’s tax rate is 40 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 $41 million? Number of coupon bonds 41000 a-2. How many of the zeroes would you need to issue? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Number of zero coupon bonds b-1. In 20 years, what will your company’s repayment be if you issue the coupon bonds? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, i.e. 1,234,567.) Coupon bonds repayment $ b-2. What is the repayment if you issue the zeroes? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, i.e. 1,234,567.) Zeroes repayment $ c. Calculate your company's total aftertax cash flow during the first year for each type of bond (don't include the initial amount raised). Don't forget to adjust the cash flow for taxes. (Do not round intermediate calculations and enter your answers in dollars, not millions of dollars, i.e. 1,234,567.) Coupon bonds $ Zero coupon bonds $
Explanation / Answer
A)
a-1) Bonds 8%
Market interest rate = 8% = required return
Coupon rate = 8%
Bond issue = par value = $1000
Bonds need to issue = $41,000,000 / $1000 = 41000
a-2) Zeros
FV = future value = $1000
i = interest rate = 8%
t = number of complete years = 20 years
FV = PV * (1 + i)^t
$1000 = PV * (1+ 0.08)^20
PV = 214.55
Bonds = 41000000 / 214.55 = 191097.65
B)
B-1) Bonds 8%
Coupon repayment amount (C) maturity in 20 years
FV = $41000000
= $ 3280000 PMT of int [(0.08)* 41000000]
===$ 44280000 repaid
B-2) Zeros
= 191097.65 bonds * $1000
= 191097650
C)
Coupon bonds
Interest Expense per year = $3280000
After tax effect = (1- 0.30)
After tax cash outflow = 2296000
Zeros
At year=0
At year=1
Where
FV = future value = $1000
i = interest rate = 8%
t = number of complete years = 20 years
FV = PV * (1 + i)^t
$1000 = PV * (1+ 0.08)^20
PV = 214.55
Where
FV = future value = $1000
i = interest rate = 8%
t = number of complete years = 19 years
FV = PV * (1 + i)^t
$1000 = PV * (1+ 0.08)^19
PV = 231.71
PV = 214.55
PV = 231.71
Interest = (231.71 – 214.55)
= 17.16
Cash flow = 17.16 * 191097.65 bonds * (.30)
= 983770.7
At year=0
At year=1
Where
FV = future value = $1000
i = interest rate = 8%
t = number of complete years = 20 years
FV = PV * (1 + i)^t
$1000 = PV * (1+ 0.08)^20
PV = 214.55
Where
FV = future value = $1000
i = interest rate = 8%
t = number of complete years = 19 years
FV = PV * (1 + i)^t
$1000 = PV * (1+ 0.08)^19
PV = 231.71
PV = 214.55
PV = 231.71
Interest = (231.71 – 214.55)
= 17.16
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