The Bowman Corporation has a bond obligation of $26 million outstanding, which i
ID: 2765802 • Letter: T
Question
The Bowman Corporation has a bond obligation of $26 million outstanding, which it is considering refunding. Though the bonds were initially issued at 11 percent, the interest rates on similar issues have declined to 9.9 percent. The bonds were originally issued for 20 years and have 10 years remaining. The new issue would be for 10 years. There is a call premium of 7 percent on the old issue. The underwriting cost on the new $26,000,000 issue is $560,000, and the underwriting cost on the old issue was $450,000. The company is in a 35 percent tax bracket, and it will use an 10 percent discount rate (rounded aftertax cost of debt) to analyze the refunding decision. Use Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods. a. Calculate the present value of total outflows. (Do not round intermediate calculations and round your answer to 2 decimal places.) PV of total outflows $ b. Calculate the present value of total inflows. (Do not round intermediate calculations and round your answer to 2 decimal places.) PV of total inflows $ c. Calculate the net present value. (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places.) Net present value $ d. Should the old issue be refunded with new debt? Yes No
Explanation / Answer
Bowman Corporation
Outflows:
$26,000,000 * 7% = $1,820,000
After tax call premium = $1,820,000 (1-0.35)
After tax payment of call premium = $1,183,000
Amortization of Costs = $56,000 ($560,000 / 10 years)
Tax on amortization cost = $19,600 ($56,000 * 0.35) tax saving per year
Actual expenditure = $560,000
PV of future tax savings ($19,600 * 6.1445) = $120,432
Net cost of underwriting expense on new issue = $439,563
Inflows:
11% (interest on old bond) * $26,000,000 = $2,860,000 per year
9.9% (Interest on new bond) * $26,000,000 = $2,574,000 per year
Saving per year before taxes = $286,000
After-tax Savings $286,000 * (1-0.35) = $185,900 per year
Present value of Savings ($185,000 * 6.1445) = $1,142,262
Original Amount = $450,000
Amount written off over 10 years at $20,000 per year = $200,000
Unamortized old underwriting cost = $200,000
Present value of deferred future write-off ($20,000 * 6.1445) = $122,890
Immediate gain in old underwriting cost write-off = $77,110
After tax value of immediate gain in old underwriting cost write-off = $26,988 ($77,110 * 0.35)
Summary:
Total PV of Inflows ($1,142,262 + $26,988) = $1,169,250
Total PV of Outflow ($1,183,000 + $439,563) = $1,622,563
Net Present Value = ($453,313)
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