The Bowman Corporation has a bond obligation of $26 million outstanding, which i
ID: 2779467 • 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. Calculate your final answer using the formula and financial calculator methods.
A) Calculate the present value of total outflows
B) Calculate the present value of total inflows
C) Calculate the net present value.
Explanation / Answer
A)Lets suppose the refunding decision takes place.
Repayment of existing bonds = 26,000,000 * (1 + 7%) = $27,820,000
Cash Outflowflow at year 0 = 27,820,000 - Issue size + underwriting cost = 27,820,000 - 26,000,000 + 560,000 = $2,380,000
Cash Flow from year 1 to 9 = 9.9% * 26,000,000 * (1 - Tax Rate)= $2,574,000 * 0.65 = $1,673,100
Cash Flow in year 10 = 1,673,100 + 26,000,000 = $27,673,000
The Cash Outflows are as follows
Present Value of total outflows = $22684600.75
B) Cash inflows would be those which would not have to be paid due to the refunding taking place. In other words, it will be the cash outflows had there been no refunding.
Cash flow in year 0 = 0
Cash Flow from year 1 to 9 = 11% * 26,000,000 * (1 - Tax Rate) = $2,860,000 * 0.65 = $1,859,000
Cash Flow in year 10 = (1,859,000 + 26,000,000) = $27,859,000
Cash Inflows would be
The present value of cash inflows would be = $21,446,875.77
C) Net Present Value = Present value of total inflows - Present Value of total outflows
=21446875.77 - 22684600.75 = -$1,237,724.98
Since the net present value is negative,, refunding should not be taken.
Year Cash Flow Discounted Cash Flow 0 2,380,000 2380000.00 1 1,673,100 1521000.00 2 1,673,100 1382727.27 3 1,673,100 1257024.79 4 1,673,100 1142749.81 5 1,673,100 1038863.47 6 1,673,100 944421.33 7 1,673,100 858564.85 8 1,673,100 780513.50 9 1,673,100 709557.73 10 27,673,100 10669178.00 PV 22684600.75
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