Suppose your company needs to raise $14 million and you want to issue 27-year bo
ID: 2774865 • Letter: S
Question
Suppose your company needs to raise $14 million and you want to issue 27-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 8 percent semiannual coupon bond and a zero coupon bond. Your company's tax rate is 34 percent.
You will need to issue _________________ of the zeroes to raise the $14 million. (Round your answers to the nearest whole number. (e.g., 32))
In 27 years, your company's repayment will be $______________ if you issue the coupon bonds. (Do not include the dollar sign ($).)
If you issue the zeroes, your company's repayment will be $____________. (Do not include the dollar sign ($). Do not round your intermediate calculations. Round your answers to the nearest whole number. (e.g., 32))
Your aftertax cash outflow for the first year will be $______________ if you issue the coupon bonds, and a cash inflow of $___________ if you issue the zeroes. (Do not include the dollar signs ($). Do not round your intermediate calculations. Round your answers to the nearest whole number. (e.g., 32))
Suppose your company needs to raise $14 million and you want to issue 27-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 8 percent semiannual coupon bond and a zero coupon bond. Your company's tax rate is 34 percent.
Explanation / Answer
Solution: Total amount to be raised = $14,000,000, Required rate of return (K) = 8%
a. Now for semiannual coupon bonds
Since, the coupon is paid 2 times in an year, Coupon rate = 4% (8%/2), Cost of raising capital = 4% (8%/2), Number of periods = 54 (27*2), Par value of bond = $1,000
Now since the coupon rate and cost of capital are equal, the present value of the bond will be equal to par value of the bond
hence, present value of bond = $1,000
Total amount to be raised = $14,000,000, Value of one bond = $1,000
hence, number of bonds = 14,000,000/1,000 = 14,000
hence, the company needs to issue 14,000 semiannual coupon bonds to raise the issue
For Zero coupon bond,
since there is no coupon, the only payment to bond holder is the par value at the maturity of the bond
Hence, the present value of such bond = Par value/(1+K)^n
Here, Par value = $1,000, K = 8%, n = 27 years
Present value of bond = 1000/(1+8%)^27
= 1000/7.988
= 125.19
Hence, value of such zero coupon bond = $125.19
Here total number of bonds required will be = 14,000,000/125.19
= 111,832.86
hence, the company need to issue ~111,833 zero coupon bonds to raise the issue
b. For semiannual coupon bonds,
company will be paying semi annual coupon of $400 (4% of 1000) for 54 periods, and $1,000 at end of the maturity period,
Hence the total repayment by the company for one bond = 400*54 + 1000
= 21,600 + 1,000
= 22,600
Total repayment for all bonds = Number of bonds * repayment for one bond
= 14,000 * 22,600
= 316,400,000 = $316.4 million
For Zero coupon bond,
the only repayment by the company is the par value at the end of 27 years,
hence, repayment by the company for one bond = $1,000
For all the bonds, repayment = number of bonds * repayment for one bond
= 111,832.86 * 1000
= $111,832,860.56
C. For semiannual coupon bonds,
Cash outflow after 1 year = Number of coupons *(Coupon payment after 6 months + coupon payment after 12 months)
= 14,000 *(400 + 400)
= 14,000 *800
= 11,200,000
Since, it will be tax deductible
Net outflow = 11,200,000 * (1-34%)
= 11,200,000 * 0.66
= $7,392,000
For Zero coupon bond,
since there is no coupon payment, there will be '0' cash inflow
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