Debt Retirement MTF Inc. is a manufacturer of electronic components for facsimil
ID: 2777201 • Letter: D
Question
Debt Retirement
MTF Inc. is a manufacturer of electronic components for facsimile equipment.
The company financed the expansion of its production facilities by issuing $100 million of 10-year bonds carrying a coupon rate of 8% with interest payable annually on December 31.
The bonds had been issued on January 1. At the time of the issuance, the market rate of interest on similar risk-rated instruments was 6%.
Two years later, the market rate of interest on comparable debt instruments had climbed to 12%. The CEO of MTF realized that this might be an opportune time to repurchase the bonds, particularly because an unexpected surplus of cash made the outstanding debt no longer necessary.
Required
1. Calculate the proceeds received by the company when the debt was initially sold.
Use Excel or a financial calculator for your computations. Round your answer to the nearest dollar.
$______
2. Calculate the interest expense for each of the two years that the bonds were outstanding.
Do not round until final answer. Round answers to the nearest dollar.
Year 1 $____
Year 2 $____
3. Calculate the amount of cash needed to retire the debt after 2 years assuming a market yield rate of 12%.
Use Excel or a financial calculator for your computations. Round your answer to the nearest dollar.
$Answer____
Calculate the amount of the gain or (loss) that would result from early retirement of the debt.
Do not round until final answer. Round answers to the nearest dollar.
$_____Answer
Explanation / Answer
Answer for question no.1:
Funds to be raised =$100 millions.
Price of the bond is the present value of the bonds+Present value of the interest payments using market rate of interest as the discount rate.
Interest rate on the bonds=8%.
Market rate of the similar bond issues =6%. This means bonds are issued at premium.
Interest on coupon to be paid=$100 million* 8%
=8 million. Present value of interest payment over a period of ten years discount at 6% interest rate.
Using excel formula PV(rate,nper,pmt) present value of interest payments is arrived as PV(6%,10, 8,000,000)=$58,880,696.41--------(A)
Terminal cash to be paid at the time of maturity of bonds = $100 million * Present value factor @6% at 10th year
=$100 million *0.558395
=$55,839,477.69----(B)
Therefore proceeds received at the time of issue of debt =A+B
=$114,720,174.10
Answer for question 2:
Interest expense per year =$8,000,000 - ammortization of premium on bonds issued
Bond premium =$14,720,174.10
Straight line ammortization of bond premium = $14,720,174.10/10
=$1,472,017.41.
Therefore interest expense = $8,000,000-$1,472,017.41.
$6,527,982.59
Therefore interest expense for year 1 and year 2=$6,527,982.59. rounded to $6,527,983.
Answer for subpoint 3:
Market yield if the interest rate is 12%.
Remaining term of the bonds=8 years.
Current bond price with market yield of 12%=Present value of interest payments+Present value of bonds principal amount.
Interest rate on the bonds=8%.
Market rate of the similar bond issues =6%. This means bonds are issued at premium.
Interest on coupon to be paid=$100 million* 8%
=8 million. Present value of interest payment over a period of eight years discount at 12% interest rate.
Using excel formula PV(rate,nper,pmt) present value of interest payments is arrived as PV(12%,8, 8,000,000)=$39,741,118.13--------(A)
Terminal cash to be paid at the time of maturity of bonds = $100 million * Present value factor @12% at 8th year
=$100 million *0.40388
=$40,388,323---------------(B)
Therefore proceeds received at the time of issue of debt =A+B
=$80,129,441.
Therefore, amount needed to retire =$80,129,441.
Answer for question no.4:
Gain on early retirement of debt = Book value of bonds- amount paid for retirement of bonds.
Book value of bonds=value of bonds received - bond premium ammortized
= $114,720,174.10 - $1,472,017.41*2
=$114,720,174.10- $2,944,035
=$111,776,139.28
Gain = $111,776,139.28 - $80,129,441
=$34,590,733.17
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