IBM has $150 million of 10% sinking-fund debentures outstanding. The issue amortizes in equal annual amounts...

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?

Solutions

Expert Solution

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%.

jeff jeffy answered 2 years ago

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