Question

In: Accounting

NARRBEGIN: Loose Cannon refunding Loose Cannon Co. Loose Cannon Co. is evaluating a new $75 million...

NARRBEGIN: Loose Cannon refunding

Loose Cannon Co.

Loose Cannon Co. is evaluating a new $75 million bond issue, the proceeds of which would be used to call and retire its outstanding $75 million bonds. Details on both bond issues are presented below. The firm is in the 35% tax bracket.

Old Bonds The old issue sold at par, with a coupon rate of 11 percent. It was issued five years ago with a twenty year maturity. The issue had $350,000 in flotation costs and carries a call price of $1150.

New Bonds The new issue are expected to sell at par with an 8.5 percent coupon rate and a 15 year maturity. Flotation costs are forecast to be $500,000. Interest payments will overlap for 2 months while the old bonds are retired.

NARREND

Refer to Loose Cannon Co. What is the initial investment required to refund the bonds?

a.

$11,250,000

b.

$8,614,375

c.

$7,312,500

d.

$3,937,500

ANS: B   

Refer to Loose Cannon Co. What are the annual cash flows associated with the new bonds?

a.

$4,143,750

b.

$6,375,000

c.

$4,132,083

d.

$6,357,051

ANS: C                                              

Refer to Loose Cannon Co. What is the NPV of the refunding decision?

a.

$3,654,164

b.

$5,356,375

c.

$1,224,292

d.

$8,614,375

ANS: A                      

Solutions

Expert Solution

1. Calculation of initial investment required to refund the bonds :

Particulars Amount ($)
Cash Outflow on redemption of old bonds (750,00,000 * 1150 / 1000) 8,62,50,000
Less : Cash Inflow on New bond issue (7,50,00,000)
Less : Call Premium Tax Shield (1,12,50,000 * 35%) (39,37,500)
Less : Tax shied on unamortised floatation cost of old bonds (3,50,000 / 20 * 15 * 35%) (91,875)
Add : New bonds floatation cost 5,00,000
Add : Overlapping Interest [(7,50,00,000 * 11 % * 2 / 12) -35%] 8,93,750
Initial Investment 8,614,375

Hence , Option B is correct.

2. Calculation of annual cash flows associated with new bonds :

Particulars Amount ($)
Annual Coupon on new bonds (net of tax shield) [(7,50,00,000 * 8.5%) -35%] 41,43,750
Less : Annual Tax benefit on amortization of floatation cost (5,00,000 / 15 * 35%) (11,667)
Annual cash flows associated with new bonds 4,132,083

Hence , Option C is correct.

3. Calculation of NPV of bond refunding decision :

NPV = Present Value of Cash inflows - Initial Outflow

= 12,268,539 - 8,614,375

= $ 3,654,164

Hence, Option A is correct.

ekkarill92 answered 3 years ago
Next > < Previous

Related Solutions

Refunding Analysis Mullet Technologies is considering whether or not to refund a $75 million, 13% coupon,...
Refunding Analysis Mullet Technologies is considering whether or not to refund a $75 million, 13% coupon, 30-year bond issue that was sold 5 years ago. It is amortizing $3 million of flotation costs on the 13% bonds over the issue's 30-year life. Mullet's investment banks have indicated that the company could sell a new 25-year issue at an interest rate of 11% in today's market. Neither they nor Mullet's management anticipate that interest rates will fall below 11% any time...
Refunding Analysis Mullet Technologies is considering whether or not to refund a $75 million, 15% coupon,...
Refunding Analysis Mullet Technologies is considering whether or not to refund a $75 million, 15% coupon, 30-year bond issue that was sold 5 years ago. It is amortizing $3 million of flotation costs on the 15% bonds over the issue's 30-year life. Mullet's investment banks have indicated that the company could sell a new 25-year issue at an interest rate of 9% in today's market. Neither they nor Mullet's management anticipate that interest rates will fall below 9% any time...
Problem 18-07 Refunding Analysis Mullet Technologies is considering whether or not to refund a $75 million,...
Problem 18-07 Refunding Analysis Mullet Technologies is considering whether or not to refund a $75 million, 14% coupon, 30-year bond issue that was sold 5 years ago. It is amortizing $6 million of flotation costs on the 14% bonds over the issue's 30-year life. Mullet's investment banks have indicated that the company could sell a new 25-year issue at an interest rate of 9% in today's market. Neither they nor Mullet's management anticipate that interest rates will fall below 9%...
Problem 18-07 Refunding Analysis Mullet Technologies is considering whether or not to refund a $75 million,...
Problem 18-07 Refunding Analysis Mullet Technologies is considering whether or not to refund a $75 million, 14% coupon, 30-year bond issue that was sold 5 years ago. It is amortizing $6 million of flotation costs on the 14% bonds over the issue's 30-year life. Mullet's investment banks have indicated that the company could sell a new 25-year issue at an interest rate of 10% in today's market. Neither they nor Mullet's management anticipate that interest rates will fall below 10%...
Problem 18-07 Refunding Analysis Mullet Technologies is considering whether or not to refund a $75 million,...
Problem 18-07 Refunding Analysis Mullet Technologies is considering whether or not to refund a $75 million, 14% coupon, 30-year bond issue that was sold 5 years ago. It is amortizing $6 million of flotation costs on the 14% bonds over the issue's 30-year life. Mullet's investment banks have indicated that the company could sell a new 25-year issue at an interest rate of 9% in today's market. Neither they nor Mullet's management anticipate that interest rates will fall below 9%...
Solar Co. is evaluating a proposal to build a new solar plant. The new plant costs...
Solar Co. is evaluating a proposal to build a new solar plant. The new plant costs $225 million today (at t = 0), and the expected salvage value of the plant in eight years is $43 million (at t = 8). Based on these assumptions, the NPV of this project is $20 million. Now suppose the project team made an error, and the expected salvage value of the plant is zero in eight years (at t = 8). By how...
Fast Turnstiles Co. is evaluating the extension of credit to a new group of customers. Although...
Fast Turnstiles Co. is evaluating the extension of credit to a new group of customers. Although these customers will provide $270,000 in additional credit sales, 9 percent are likely to be uncollectible. The company will also incur $16,700 in additional collection expense. Production and marketing costs represent 75 percent of sales. The firm is in a 35 percent tax bracket and has a receivables turnover of four times. No other asset buildup will be required to service the new customers....
Fast Turnstiles Co. is evaluating the extension of credit to a new group of customers. Although...
Fast Turnstiles Co. is evaluating the extension of credit to a new group of customers. Although these customers will provide $126,000 in additional credit sales, 9 percent are likely to be uncollectible. The company will also incur $15,900 in additional collection expense. Production and marketing costs represent 70 percent of sales. The firm is in a 35 percent tax bracket and has a receivables turnover of four times. No other asset buildup will be required to service the new customers....
Fast Turnstiles Co. is evaluating the extension of credit to a new group of customers. Although...
Fast Turnstiles Co. is evaluating the extension of credit to a new group of customers. Although these customers will provide $486,000 in additional credit sales, 12 percent are likely to be uncollectible. The company will also incur $17,800 in additional collection expense. Production and marketing costs represent 75 percent of sales. The firm is in a 35 percent tax bracket and has a receivables turnover of four times. No other asset buildup will be required to service the new customers....
Harriman Manufacturing Co. is evaluating the purchase of a new forklift. The quoted price is $50,000,...
Harriman Manufacturing Co. is evaluating the purchase of a new forklift. The quoted price is $50,000, and it would cost Harriman another $10,000 for related capital costs such as transportation and equipment modification for special use. The total investment would fall into MACRS three year class with depreciation rates being applied to the full capitalized costs, not deducting salvage, at 33%, 45%, 15% and 7% in years 1-4, respectively. Harriman expects that the equipment would be sold in the fourth...
ADVERTISEMENT
Subjects
ADVERTISEMENT
Latest Questions
ADVERTISEMENT