In: Finance
IBM has $150 million of 10% sinking-fund debentures outstanding. The issue amortizes in equal annual amounts at the ends of years 10, 11, and 12. The firm can call the bonds at 103%. Its new issue rate is 8% for 10-year debt, 8.5% for 11-year debt, and 9% for 12-year debt. Its marginal income tax rate is 40%. Post the net advantage of refunding for each one. Which sinking-fund amounts should the firm call?
New issue rate is 8% for 10-year debt Then Net advantage = 4.54%.
New issue rate is 8.5% for 11-year debt Then Net advantage = 4.85%.
New issue rate is 9% for 12-year debt then Net advantage = 5.15%.
The firm should call Its new issue rate is 8% for 10-year debts sinking-fund amounts.
Base for the
Solution:
The bond call price is 103%. thus call price = 1,030
Face value bond = $1,000
Yield to call for each of these bonds (the net advantage) is given by "RATE" function on excel.
New issue rate is 8% for 10-year debt:
Yield to call = "=rate(10,80,-1030,1000)" = 7.56%.
After-tax yield to call = 7.56% * (1 - 0.40)
= 4.54%.
New issue rate is 8.5% for 11-year debt:
Yield to call = "=rate(11,85,-1030,1000)" = 8.08%.
After-tax yield to call = 8.08% * (1 - 0.40)
=4.85%.
New issue rate is 9% for 12-year debt:
Yield to call = "=rate(12,90,-1030,1000)" = 8.59%.
After-tax yield to call = 8.59% * (1 - 0.40)
= 5.15%.