Homework Answers
| STEP1 | ||||||||||
| Discount Rate =After Tax cost of new debt | ||||||||||
| Interest rate for the new Bond | 10.00% | |||||||||
| Flotation cost of new Bond as percentage | 4.00% | |||||||||
| Before tax cost of new debt=10/(1-0.04)= | 10.42% | |||||||||
| Tax Rate =40% | ||||||||||
| After tax cost of new debt =10.42*(1-0.4) | 6.25% | |||||||||
| Semi annual after tax cost =6.25/2= | 3.125% | |||||||||
| SEMI ANNUAL DISCOUNT RATE | 3.125% | |||||||||
| STEP2 | ||||||||||
| Present Value (PV) of total outflows: | ||||||||||
| Investment Outlay: | ||||||||||
| Call Premium on old Issue=11% | ||||||||||
| Before tax Call Premium paid on old bond=$20million*11% | ($2,200,000) | |||||||||
| B | After tax Call Premium paid on old bond=2200000*(1-0.40) | ($1,320,000) | ||||||||
| C | Flotation cost on new bond=20million*4% | ($800,000) | ||||||||
| Flotation cost incurred on old bond=6%*$20million | $1,200,000 | |||||||||
| Number of years to maturity of old Bond | 25 | 6 | ||||||||
| Annual amortization=1200000/25 | $48,000 | |||||||||
| Unamortized Flotation cost =48000*20= | $960,000 | |||||||||
| D | immediate tax saving on unamortized Flotation cost =960000*0.4 | $384,000 | ||||||||
| G=B+C+D | Present Value (PV) of total Cash Outflow | ($1,736,000) | ||||||||
| STEP3 | ||||||||||
| Present Value of total inflows | ||||||||||
| Annual Tax Shield on amortization expense of Flotation cost (New Bond) | $16,000 | (800000/20)*40% | ||||||||
| Tax Shield lost on amortization expense of Flotation cost Old Bond) | ($19,200) | (48000*40%) | ||||||||
| H | Net annual tax shield on amortization cost of Flotationexpenses | ($3,200) | (16000-19200) | |||||||
| After tax interest savings on old issue=$20million*12%*(1-0.4) | $1,440,000 | |||||||||
| After tax interest cost on new bond=$20million*10%*(1-0.4) | ($1,200,000) | |||||||||
| I | Net annual interest savings | $240,000 | ||||||||
| X=H+I | Net Annual Cash inflows | $236,800 | ||||||||
| Pmt=X/2 | Net Semi-Annual Cash inflows=236800/2 | $118,400 | ||||||||
| Rate=STEP1 | Semi annual Discount Rate | 3.125% | ||||||||
| Nper | Number of Semi annual periods=20*2 | 40 | ||||||||
| PV | Present Value (PV)of total inflows | $2,682,321 | (Using PV function of excel with Rate=3.125%, Nper=40, Pmt=-118400) | |||||||
| NET PRESENT VALUE | ||||||||||
| NPV=PV+G | Net Present Value =2682321-1736000 | $946,321 | ||||||||
| NET PRESENT VALUE IS POSITIVE | ||||||||||
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