Question

Problem 16-20 (Modified) The Harding Corporation has $50.5 million of bonds outstanding that were issued at a coupon rate of 1275 percent seven years ago. Interest rates have fallen to 11.5 percent. Preston Alter, the vice-president of finance, does not expect rates to fall any further. The bonds have 18 years left to maturity, and Preston would like to refund the bonds with a new issue of equal amount also having 18 years to maturity The Harding Corporation has a tax rate of 30 percent. The underwriting cost on the old issue was 3.0 percent of the total bond value. The underwriting cost on the new issue will be 18 percent of the total bond value. The premium for calling the bond early is 75 percent. Use Appendix D a. Compute the discount rate (Round the final answer to 2 decimal places.) Discount rate b. Calculate the present value of total outflows. (Enter the answers in whole dollars, not in millions. Round "PV Factor" to 3 decimal places. Do not round intermediate calculations. Round the final answer to nearest whole dollar.) Total outflows c. Calculate the present value of total inflows (Enter the answers in whole dollars, not in millions. Round "PV Factor" to 3 decimal places. Do not round intermediate calculations. Round the final answer to nearest whole dollar.) Total inflows d. Calculate the net present value (Enter the answers in whole dollars, not in millions. Round "PV Factor" to 3 decimal places. Do not round intermediate calculations, Round the final answer to nearest whole dollar. Negative amount should be indicated by a minus sign.) Net present value e. Should the Harding Corporation refund the old issue? Yes O NO

Answer 1

Part (a)

Discount rate = New interest rate x (1 - T) = 11.5% x (1 - 30%) = 8.05%

Part (b)

The PV of total outflows =  $3,233,010

Detailed working is shown below:

Current bond issue information
Par value		$        50,500,000
coupon rate		13%
original maturity		25
remaining maturity		18
original flotation costs		$          1,515,000
Call premium		7.5%
Tax rate		30%
New issue information
Coupon rate		11.50%
maturity		18
flotation costs		$             909,000
Discount rate		8.05%
Initial investment outlay to refund old issue:
Call premium on old issue =			$     3,787,500.00
After-tax call premium =			$     2,651,250.00
New flotation cost =			$        909,000.00
Old flotation costs already expensed =			$        424,200.00
Remaining flotation costs to expense =			$     1,090,800.00
Tax savings from old flotation costs =			$        327,240.00	You get to expense the remaining flotation costs
Total investment outlay =			$     3,233,010.00

Part (c)

PV of total inflows = $4,098,579

Detailed working is shown below:

Annual Flotation Cost Tax Effects:
Annual tax savings on new flotation =			$          15,150.00
Tax savings lost on old flotation =			$          18,180.00
Total amortization tax effects =			$          (3,030.00)
Annual interest savings due to refunding:
Annual after tax interest on old bond =			$     4,507,125.00
Annual after tax interest on new bond =			$     4,065,250.00
Net after tax interest savings =			$        441,875.00
Annual cash flows =			$        438,845.00

Hence, PV of all inflows = - PV (Rate, Nper, PMT, FV) = - PV (8.05%, 18, 438845, 0) = $4,098,579.17

Part (d)

NPV = PV opf all inflows - PV of all outflows = $4,098,579.17 -  $3,233,010.00 =  $865,569.17

Please enter your answer as  $865,569

Part (e)

Since NPV of bond refunding > 0, hence, the correct answer is YES