Question

The Robinson Corporation has $44 million of bonds outstanding that were issued at a coupon rate of 12.650 percent seven years ago. Interest rates have fallen to 11.750 percent. Mr. Brooks, the Vice-President of Finance, does not expect rates to fall any further. The bonds have 17 years left to maturity, and Mr. Brooks would like to refund the bonds with a new issue of equal amount also having 17 years to maturity. The Robinson Corporation has a tax rate of 30 percent. The underwriting cost on the old issue was 4.40 percent of the total bond value. The underwriting cost on the new issue will be 2.70 percent of the total bond value. The original bond indenture contained a five-year protection against a call, with a 6 percent call premium starting in the sixth year and scheduled to decline by one-half percent each year thereafter. (Consider the bond to be seven years old for purposes of computing the premium.) Use Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods. Assume the discount rate is equal to the aftertax cost of new debt rounded up to the nearest whole percent (e.g. 4.06 percent should be rounded up to 5 percent).

a. Compute the discount rate. (Do not round intermediate calculations. Input your answer as a percent rounded up to the nearest whole percent.)

Answer 1

Discount Rate = [Interest Rate × (1 – Tax Rate)]

Discount Rate = [11.750% × (1 – 30%)]

Discount Rate = 0.08225 OR 8.23%

Hence, the discount rate is 8.23%.