Question

Suppose your company needs to raise $65 million and you want to issue 30-year bonds for this purpose. Assume the required return on your bond issue will be 5 percent, and you’re evaluating two issue alternatives: A semiannual coupon bond with a coupon rate of 5 percent and a zero coupon bond. Your company’s tax rate is 21 percent. Both bonds will have a par value of $2,000.

a-1.	How many of the coupon bonds would you need to issue to raise the $65 million?
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.)
b-1.	In 30 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, e.g., 1,234,567.)
b-2.	What if you issue the zeroes? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, e.g., 1,234,567.)
c.	Calculate the aftertax cash flows for the first year for each bond. (Do not round intermediate calculations and enter your answers in dollars, not millions of dollars, e.g., 1,234,567.)

Answer 1

(a)-1

Here the Coupon rate = reuired return ,

hence issue price will be at par @$2000 per bond.

Number of Bonds needs to be issued = $65Million / $2000 = 32500 bonds

(a)-2

Price of the Zero Coupon Bond =

=>$454.5671757

Number of Zero coupon bonds to be issued = $65000000/$454.5671757 = 142993.17 Zero coupon bonds.

(b)-1

In year 30 end, the repayment will be = Principal amount+ Last Coupon Payment

=>$65000000+[$65000000*5%*1/2]

=>$66,625,000

(b)-2

Repayment for Zero Coupon bond at year 30 end = Nuber of ZCB issed* Bond Face value

=>142993.17*$2000 = $285986334.

(c)

(I)After tax cash flow for Coupon Bond = Interest * (1-Tax rate )

=>After tax cash flow for Coupon Bond=$65000000*5%*(1-0.21) = $2567500.(Out flow)

(II)For zero coupon bond = $6500000*[(1+0.05/2)^2 - 1] * 21%

=>$65000000*[1.050625-1]*21%

=>$691031.25(Inflow)