Question

The Robinson Corporation has $44 million of bonds outstanding that were issued at a coupon rate of 12.650 percent seven years ago. Interest rates have fallen to 11.750 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 4.40 percent of the total bond value. The underwriting cost on the new issue will be 2.70 percent of the total bond value. The original bond indenture contained a five-year protection against a call, with a 6 percent call premium 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

b. Calculate the present value of total outflows.

c. Calculate the present value of total inflows

d. Calculate the net present value.

*Side note: I've applied the answers to this question already by using the same question that was asked on Chegg--none were correct.

Answer 1

B 1 a) Discount rate 9% 11.75%*(1-30%) 2 3 4 5 b) Net cost of call premium Underwriting expenditure Annual tax savings (New issue) PV of tax savings (New issue) PV of total outflows 1,694,000.00 =44000000*(6%-0.5%)*(1-30%) 1,188,000.00 =44000000*2.7% 20,964.71 =(1188000/17)*30% 179,114.75 =PV(9%,17,-20964.71,0,0) $2,702,885.25 7 9 11 c) Net annual interest savings PV of interest savings Annual amortization (Old issue) Unamortized cost (Old issue) PV of unamortized cost (Old issue) Immediate gain in unamortized cost (Old issue) Cost tax savings (Old issue) 277,200.00 =44000000*(12.65%-11.75%)*(1-30%) 2,368,294.62 =PV(9%, 17,-277200,0,0) 80,666.67 =44000000*4.4%/24 1,371,333.31 =44000000*4.4%-80666.67*7 689,186.29 =PV(9%,17,-80666.67,0,0) 682,147.02 =1371333.31-689186.29 204,644.11 +682147.02*30% 16 | $ 2,572,938.72 |-+C10+C15 PV of total inflows 17 18 d) Net present value -$129,946.52 =+C16-C7

*Please rate thumbs up