Zero Coupon Bonds. Suppose your company needs to raise $45 million and you want to issue 20-year bonds for this purpose. Assume the required return on your bond issue will be 7.5 percent, and you're evaluating two issue alternatives: a 7.5 percent annual coupon bond and a zero coupon bond. Your company's tax rate is 35 percent.
a. How many of the coupon bonds would you need to issue to raise the $45 million? How many of the zeroes would you need to issue?
b. In 20 years, what will your company's repayment be if you issue the coupon bonds? What if you issue the zeroes?
c. Based on your answers in (a) and (b), why would you ever want to issue the zeroes? To answer, calculate the firm's after tax cash outflows for the first year under the two different scenarios. Assume that the IRS amortization rules apply for the zero coupon bonds.
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