Question

Question 1

The Harding Corporation has $50.7 million of bonds outstanding that were issued at a coupon rate of 10.25 percent seven years ago. Interest rates have fallen to 9 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 3.2 percent of the total bond value. The underwriting cost on the new issue will be 1.8 percent of the total bond value. The original bond indenture contained a five-year protection against a call, with an 8 percent call premium starting in the sixth year and scheduled to decline by one-half percent each year thereafter.

Required:

Should the Harding Corporation refund the old issue? Show all calculations,

Answer 1

PAGE DATE GivenoTotal Bond Value $ S070O000 eold Coupon Rave lo-25% O New Coupon Rate 9 4Tax Rae 30%.-o.30 G Discounting Rate- NewCoupon Rake (1-TaxRak) -9%. (1-0.3o) 630% 1years 6 No. ofYear left to mature FIoataton Cost of old Bonds pe year 7otal Bond Valuex Underuritiog Cost Total No. ofyears So700 DOox 3 2% 18 yeors+ 7years $64896 F1otation Cos of New Bonds Per Year $S0700000 X J.8' 18 years 2 $S070o Call Premium Rate at 7th year = 8%.-0.S% = 7.5% TO Presen Value Factor for +7) Ryes Amuiy लाजेर @ 6.309 (t+0063) O063 10-5878 DiSCOunting Factor of 18h year@6-30% O.333 (1+

DATE Now, we Compore the 2 Scenarios a f old bonds are not retired. Calalation Of Present Value ot Cash Outflows A Total Bond Value I $ S070000O Ola Coupon Rate lnterest to be pail LAXB Ohterest AFrer Tax Cc -Tax Pate -030) Present Value Annuih Facfer for years Present Value of Interes) DxE l0.25% $S196750 $ 363772S lo.S878 $385/550S Discounting Factor of 18 ahuriy Value of old bonds t present CAXG Total Present Value of Cash Outflows F+H 0.333 $168 83100 $ 55398605 ICalculaHon of Resen Nalue of Cash Inflows A Fotation Cost of old bonds per yer B Tax Saving on Fiohtion Cos LAx Tax Rate Ax 30% a Present Value Annuiy Factor for 12 y ears D Present Value of tax Cost [Bx E Present Value of Cash lnflow D $64896 $19469 10-5878 Flotati on Saving $206134 206134 1iNet Present Value ofe Cash outflow $SS192471

PAGE DATE IF 0l4 bonds are retired IResent Volue of Cash Owflow A Total Bnd Nalue $C07 00000 7.S% B Col) Premi um Rate Cal) Premivm to be paid [A 8 NewInt eres) Rate $3802 S00 g%o $ 3194100 E New Interest After Tax (AXD) (J-Tas Rete)- (AxD)1-0-30) lResent Value Ami Fachor For 3yes )o.S878 Gresent Volue of Ineres) Atler Tax $33818492 CExE Discounting Factor of 1 year Rresent Value of CAXH J Total Resent Value of Csh Outflow [c+ G +I 0333 $168 83100 Mouy Value $5p504092 Resent Value of Cash lnflows Savings on flora lion Coc of old bonds now written off 30% A Tax $350438 (&489 6x18years)a B Tax Soving 3802 S00x 3o a Flotation Cost of New bonds on Cal) Premism $ 11 407S0 per ycar D Tax $ S0700 Saving on Flotoion Cos Cex30 Present Velue Ami Fachor fr 18 yeo Rresent Value of Flotalion Cost of New $15210 l0.5878 $16104p0 Bonds

PAGE CATE G 7otal Resen Vahie ot Cosh Inflows [A+B+E 80eT591$ Net Resen) Value ol Cash Outtlons I-1D $528S1864 As ne present value of Cash oulows under bonds are etired eis less than thatof bonds are not retired, i is advisabe to rehire old bonds Thereore Hording Corporation Should reund he ola issue