Question

Roster Pte Ltd issued 100 million of 11-year bonds with a 9.5% coupon payable annually. This bond was issued a year ago. The first coupon payment has just been paid. The bonds are callable at 105 beginning today. Floatation costs on that issue were $1 million. Roster pte has 38% marginal tax rate. Roster Pte is planning to call the bonds and refinance at current rates. The following 10 years alternatives exist: (show all calculations)

a. 100 million public issue of 8% annual coupon bonds. Floatation costs would be one million.

b. 100 million private placement with 8% semi-annual coupons with a placement fee of 500000.

(Call premiums and interest payments are tax deductible but the frontend fee and floatation cost must be capitalized and amortized over the life of the bond.)

1. What will be the effective cost of raising funds from the public bond issue using IRR ?

2. Effective cost of raising funds from private placement of debt.?

3. If the bonds are called, which of two refinancing options is more preferable and why?

4. What's the effective after-tax cost of refinancing that would make Roster Pte indifferent calling the bonds and leaving them as it is?

5. Should the bonds be called in? why or why not?

Answer 1

Please refer to the attached files for detailed calculations of each part. Some notes for the format of attached file:

1) The files contain calculations for different scenarios. First two tables are the IRR calculation for effective cost of raising funds for public bond issue and private placement of debt respectively. Third table is the IRR calculation for existing bond issue. Fourth and last table considers the refinancing option (with public issue) and provides to check the IRR for different refinancing rates.

2) Each table has tax benefit calculations done separately for coupon payments, amortization and call premium. These are calculated as follows:

Tax benefit on coupon payment = Coupon Value * 38%

Tax Benefit on floatation cost amortization = (Floatation cost/Duration of bond)*38%. In case of refinancing the floatation cost for both the issues will be considered

table 2a and 2b are part of the same calculation.

Table 1