Question

Your company needs to raise $46 million to finance a new factory. You’re evaluating two different 25-year bonds to raise these funds: a coupon bond with an annual coupon rate of 7 percent; and a zero coupon bond. Your company’s tax rate is 30 percent. Both bonds will have a par value of $1,000, and a  required annual return of 7 percent with semi-annual compounding.

a-1.	How many of the coupon bonds would you need to issue to raise the $46 million?

Number of coupon bonds

a-2.	How many of the zeroes would you need to issue? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Number of zero coupon bonds

b-1.	In 25 years, what will your company’s repayment be if you issue the coupon bonds? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, i.e. 1,234,567.)

Coupon bonds repayment

$

b-2.	What is the repayment if you issue the zeroes? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, i.e. 1,234,567.)

Zeroes repayment

$

  

c.

Calculate your company's total aftertax cash flow during the first year for each type of bond (don't include the initial amount raised). Don't forget to adjust the cash flow for taxes. (Do not round intermediate calculations and enter your answers in dollars, not millions of dollars, i.e. 1,234,567.)

  

Coupon bonds	(Click to select)InflowOutflow	$
Zero coupon bonds	(Click to select)OutflowInflow	$

Answer 1

Formula sheet

A	B	C	D	E	F	G	H	I	J
2
3		a-1)
4
5		Number of Bonds to be issued	=Amount to Raised / Current Price of the Bond
6
7		Amount to be Raised	46	million
8
9		Since required rate of return is same as the coupon rate,
10		therefore the price of coupon bond will be equal to the par value of the bond.
11		Par Value of coupon Bond	1000
12		Current price of Coupon Bond	=D11
13
14		Number of Coupon Bonds to be issued	=Amount to Raised / Current Price of the Copun Bond
15			=D7/D12	=D7/D12
16
17		Hence Number of coupon Bonds to be issued is	=D15	million
18
19		a-2)
20
21		Number of Bonds to be issued	=Amount to Raised / Current Price of the Bond
22
23		Amount to be Raised	46	million
24
25		Required rate of return	0.07
26
27		Price of zero coupon bond will be the present value of the face value.
28		Par Value of coupon Bond	1000
29		Maturity	25	Years
30		Current price of Zero Coupon Bond	=D28/((1+D25)^D29)	=D28/((1+D25)^D29)
31
32		Number of Zero Coupon Bonds to be issued	=Amount to Raised / Current Price of the Copun Bond
33			=D23/D30	=D23/D30
34
35		Hence Number of zero coupon Bonds to be issued is	=D33	million
36
37		b-1)
38		Number of Bond Issued	=D17	million
39		Par value (F)	1000
40		Coupon rate	0.07
41		Time to maturity	25	Years
42
43		Interest is paid twice a year i.e. semiannual.
44		Semiannual coupon (C)	=D39*D40/2
45		Semiannual Period (n)	=D41*2
46
47		Total amount repaid per bond	=D45*D44+D39	=D45*D44+D39
48
49		Total Amount Repaid	=Number of bonds issued*Amount Repaid per Bond
50			=D47*D38	=D47*D38
51
52		Hence Total amount Repaid is	=D50	million
53
54		b-2)
55
56		Number of Bond Issued	=D35	million
57		Par value (F)	1000
58
59		Par value will be repaid for coupon bond at the maturity
60
61		Total Amount Repaid	=Number of bonds issued*Amount Repaid per Bond
62			=D56*D57	=D56*D57
63
64		Hence Total amount Repaid is	=D62	million
65
66		c)
67		Number of Coupon Bonds Issued	=D17	million
68		Coupon paid on coupon bond in 1st year	=D39*D40
69		Tax Rate	0.3
70
71		After Tax Cash Outflow on coupon bond in first year	=Number of Bonds issued*Coupon paid*(1-Tax Rate)
72			=D67*D68*(1-D69)	=D67*D68*(1-D69)
73
74		Hence After Tax Cash Outflow on coupon bond in first year	=D72	million
75
76		Since zero coupon bond doesn't pay any coupon,
77		therefore cash outflow in case of zero coupon bond will be 0.
78
79		Hence After Tax Cash Outflow on zer coupon bond in first year	0	million
80