Question

vear, $1,000 bonds with a co a with a coupon f$1,050 were sold 16-3 ount of $45,000. The initial $1.5 million new issue ds. The company the price The Lavely Company issued $1.5 million of 30-year, $1.000 rate of 9 percent five years ago. The bonds with a call at a discount of $30 per bond or with a total discount of flotation cost was $18,000. The company wishes to sell a $1.5 mil vear bonds in order to retire its existing bonds. The intends to sell its new bonds at their face value of $1,000 per bond costs of the new issue are estimated to be $22,000. The company's rate is 50 percent and the new bonds are sold four months before the are called 000 per bond. The flotation The company's marginal tax efore the old bonds (a) Determine the net cash outflow of the refunding operation. (b) Determine the annual interest savings of the refunding operation (c) Determine the present value of the interest savings over a 25-year period at a 5 percent discount rate. (d) Should the company refund its old bonds? (e) Use the internal-rate-of-return approach to determine whether the company should refund its old bonds or not.

16-3 Everything is the same except that ‘issued $2 million’ ‘with a coupon rate of 8 percent’ ‘a call price of $1,060’ at a discount of $20 per bond’ ‘total discount of $40,000. ‘flotation cost was $25,000’ ‘a $2 million new issue of 6 percent’ ‘The flotation … $30,000.’ ‘The … tax rate is 40 percent’, and (c) ‘at a 3.6 percent’.

Answer 1

Part(a) Net Cash oulflow - Cashout flow - Cash Inflow = 2024,000 - 1979 oud = $ 54,000 working Note Calculation of cash Inflow faulticulars Amount Issue of New Bonds 2000000 & Floatation Cost 30,000 Cash Inflow | 19,70,000 Calculation of cash out flow Particulari Amount Amount of Bonds seedeemed Intriest paid on new 2,000,000 Bonds for four months as they are issued four months priod 200000 X 60/• XT Tax Savings 40000 x 40.60 - (16000) २५,००० 72024,000 I 40000

Part ( b e Calculation of Annual Inforest Savings = Interest paid on old bonds - loulorest pad en news Bonds where Interest paid on old Bonds is '. - 2000000 X 840 = 169000 Tax savings 160000X40/= _64000 where interest paid on new bond is u - 96000 2000000 X 670 = 120000 e Teak Saung|20,000 XYo! = 480oo 72,000 Interest Savings Cannually) – 96,000 - 72000 = $24,000

DATE PAGE I Presentvalue of Calculation of interest saving overa 25-yr period Fast of All, Discount rate should be nel tax Therefore interest rate = 3.6% (1-40%) I 2.16%0. Now, we need UAE of 2.16% over a period of 25 years this can be calculated by two melhods Forst is (tt0.0216"+ CI+0.021612 *ovom Felto Quiles ou Semply, we can use PU AF table So, the PVAF = 19.16 Now, the feresent value of Interest Saving - Interest saving XP VAR - $24000 x 19.16 5 $459840 (approx)

Part (d) should the company refund & Ned Benefit Cash inflow it Present value of Tax Saving - - Cash out fou - 2024000 Lusing parta) 1970000 + 45 9890 Lusing parta) (using partly $ 405 8 40

PAGE Since the net Benifit is $405,840 Therefore, company should refund its old A Bonas,