The Robinson Corporation has $38 million of bonds outstanding that were issued a
ID: 2789753 • Letter: T
Question
The Robinson Corporation has $38 million of bonds outstanding that were issued at a coupon rate of 12.050 percent seven years ago. Interest rates have fallen to 11.050 percent. Mr. Brooks, the Vice-President of Finance, does not expect rates to fall any further. The bonds have 17 years left to maturity, and Mr. Brooks would like to refund the bonds with a new issue of equal amount also having 17 years to maturity. The Robinson Corporation has a tax rate of 30 percent. The underwriting cost on the old issue was 3.80 percent of the total bond value. The underwriting cost on the new issue will be 2.40 percent of the total bond value. The original bond indenture contained a five-year protection against a call, with a call premium of 8 percent starting in the sixth year and scheduled to decline by one-half percent each year thereafter. (Consider the bond to be seven years old for purposes of computing the premium.) Use Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods. Assume the discount rate is equal to the aftertax cost of new debt rounded up to the nearest whole percent (e.g. 4.06 percent should be rounded up to 5 percent) a. Compute the discount rate. (Do not round intermediate calculations. Input your answer as a percent rounded up to the nearest whole percent.) b. Calculate the present value of total outflows. (Do not round intermediate calculations and round your answer to 2 decimal places.) c. Calculate the present value of total inflows. (Do not round intermediate calculations and round your answer to 2 decimal places.) d. 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.)
Explanation / Answer
Soln : a) At present the rates has been dropped to r = 11.050%.
So discount rates would be, R = r*(1-tax rate) = 11.050*(1-0.30) = 11.050*0.7 = 7.74% = 8%
b) Present value of cash outflows = cost of old bond issued + underwriting charges
As old bond has 17 years left of maturity, rate is being taken as 7.74% for calculation
Please refer here the table, we have taken the coupon in each year and in the 8,9,10th year we have taken call premium with 5%,3.5%,2% respectively
Net present value of cash outflows = $55.29 mn + (3.8+2.4)%*38 = 55.29+ 2.356 = -$57.65 mn
c) Inflows while issuing new bonds of 17 years and coupon rate = 11.05%, here the call premium is not considered
Accordingly the value has been calculated
Total present values of the inflows = $49.67 million
Net present value = -57.65 +49.67 = -$7.98 million net cash outflows
Years 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 Outflows 4.579 4.579 4.579 4.579 4.579 4.579 4.579 6.479 5.909 5.339 4.579 4.579 4.579 4.579 4.579 4.579 42.579 rate 1.08 1.16 1.25 1.35 1.45 1.56 1.69 1.82 1.96 2.11 2.27 2.45 2.64 2.84 3.06 3.30 3.55 Present value 4.25 3.94 3.66 3.40 3.15 2.93 2.72 3.57 3.02 2.53 2.02 1.87 1.74 1.61 1.50 1.39 11.99Related Questions
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