| | | | | | | | | 4/19/10 |
| Chapter 20. Ch 20-06 Build a Model |
| Note: Fill in the shaded cells with the appropriate formula |
| Schumann Shoe Manufacturer is considering whether or not to refund a $70 million, 10% coupon, 30-year bond issue that was sold 8 years ago. It is amortizing $4.5 million of flotation costs on the 10% bonds over the issue's 30-year life. Schumann's investment bankers have indicated that the company could sell a new 22-year issue at an interest rate of 8 percent in today's market. Neither they nor Schumann's management anticipate that interest rates will fall below 6 percent any time soon, but there is a chance that interest rates will increase. |
| A call premium of 10 percent would be required to retire the old bonds, and flotation costs on the new issue would amount to $5 million. Schumann's marginal federal-plus-state tax rate is 40 percent. The new bonds would be issued 1 month before the old bonds are called, with the proceeds being invested in short-term government securities returning 5 percent annually during the interim period. |
| Current bond issue data |
| Par value | | | $ 70,000,000 |
| Coupon rate | | | 10% |
| Original maturity | | | 30 |
| Remaining maturity | | | 22 |
| Original flotation costs | | | $ 4,500,000 |
| Call premium | | | 10% |
| Tax rate | | | 40% |
| Refunding data |
| Coupon rate | | | 8.0000% |
| Maturity | | | 22 |
| Flotation costs | | | $ 5,000,000 |
| Time between issuing new bonds and calling old bonds (months) | | | 1 |
| Rate earned on proceeds of new bonds before calling old bonds (annual) | | | 5% |
| a. Perform a complete bond refunding analysis. What is the bond refunding's NPV? |
| Initial investment outlay to refund old issue: |
| Call premium on old issue = |
| After-tax call premium = |
| New flotation cost = |
| Old flotation costs already expensed = |
| Remaining flotation costs to expense = |
| Tax savings from old flotation costs = | | | | You get to expense the remaining flotation costs |
| Additional interest on old issue after tax = | | | | This is interest paid on the old bond issue between when the new bonds are issued and the old bonds are retired |
| Interest earned on investment in T-bonds after tax = | | | | This is interest earned on the proceeds from the new bonds before they are used to pay off the old bonds. |
| Total investment outlay = |
| Annual Flotation Cost Tax Effects: |
| Annual tax savings on new flotation = |
| Tax savings lost on old flotation = |
| Total amortization tax effects = |
| Annual interest savings due to refunding: |
| Annual after tax interest on old bond = |
| Annual after tax interest on new bond = |
| Net after tax interest savings = |
| Annual cash flows = |
| After-tax cost of new debt = |
| NPV of refunding decision = |
| b. At what interest rate on the new debt is the NPV of the refunding no longer positive? |
| Use Goal Seek to set cell D60 to zero by changing cell C27. |
|
|
| | | "Break-even" interest rate = |
skizol
ch20_p06_build_a_model.xlsx
