Question

The Harding Corporation has $50 million of bonds outstanding that were issued at a coupon rate of 10.25 percent seven years ago. Interest rates have fallen to 9 percent. Preston Alter, the vice-president of finance, does not expect rates to fall any further. The bonds have 18 years left to maturity, and Preston would like to refund the bonds with a new issue of equal amount also having 18 years to maturity. The Harding Corporation has a tax rate of 25 percent. The underwriting cost on the old issue was 2.5 percent of the total bond value. The underwriting cost on the new issue will be 1.8 percent of the total bond value. The original bond indenture contained a five-year protection against a call, with an 8 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. (Round "PV factor" to 3 decimal places.)

a. Compute the discount rate. (Round the final answer to 2 decimal places.)

Discount rate            6.75 6.75 Correct %

b. Calculate the present value of total outflows. (Do not round intermediate calculations. Enter the answers in whole dollars, not in millions. Round the final answer to nearest whole dollar.)

Total outflows           $ 3436284 3436284 Incorrect

c. Calculate the present value of total inflows. (Do not round intermediate calculations. Enter the answers in whole dollars, not in millions. Round the final answer to nearest whole dollar.)

Total inflows           $ 4801477 4801477 Correct

d. Calculate the net present value. (Do not round intermediate calculations. Round the final answer to nearest whole dollar.)

Net present value           $ Not attempted

e. Should the Harding Corporation refund the old issue?

• Yes

• No

The Harding Corporation has $50 million of bonds outstanding that were issued at a coupon rate of 10.25 percent seven years ago. Interest rates have fallen to 9 percent. Preston Alter, the vice-president of finance, does not expect rates to fall any further. The bonds have 18 years left to maturity, and Preston would like to refund the bonds with a new issue of equal amount also having 18 years to maturity. The Harding Corporation has a tax rate of 25 percent. The underwriting cost on the old issue was 2.5 percent of the total bond value. The underwriting cost on the new issue will be 1.8 percent of the total bond value. The original bond indenture contained a five-year protection against a call, with an 8 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. (Round "PV factor" to 3 decimal places.) a. Compute the discount rate. (Round the final answer to 2 decimal places.) Discount rate 6.75 6.75 Correct % b. Calculate the present value of total outflows. (Do not round intermediate calculations. Enter the answers in whole dollars, not in millions. Round the final answer to nearest whole dollar.) Total outflows $ 3436284 3436284 Incorrect c. Calculate the present value of total inflows. (Do not round intermediate calculations. Enter the answers in whole dollars, not in millions. Round the final answer to nearest whole dollar.) Total inflows $ 4801477 4801477 Correct d. Calculate the net present value. (Do not round intermediate calculations. Round the final answer to nearest whole dollar.) Net present value $ Not attempted e. Should the Harding Corporation refund the old issue? Yes No The The Harding Corporation has $50 million of bonds outstanding that were issued at a coupon rate of 10.25 percent seven years ago. Interest rates have fallen to 9 percent. Preston Alter, the vice-president of finance, does not expect rates to fall any further. The bonds have 18 years left to maturity, and Preston would like to refund the bonds with a new issue of equal amount also having 18 years to maturity. The Harding Corporation has a tax rate of 25 percent. The underwriting cost on the old issue was 2.5 percent of the total bond value. The underwriting cost on the new issue will be 1.8 percent of the total bond value. The original bond indenture contained a five-year protection against a call, with an 8 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. (Round "PV factor" to 3 decimal places.) a. Compute the discount rate. (Round the final answer to 2 decimal places.) Discount rate 6.75 6.75 Correct % b. Calculate the present value of total outflows. (Do not round intermediate calculations. Enter the answers in whole dollars, not in millions. Round the final answer to nearest whole dollar.) Total outflows $ 3436284 3436284 Incorrect c. Calculate the present value of total inflows. (Do not round intermediate calculations. Enter the answers in whole dollars, not in millions. Round the final answer to nearest whole dollar.) Total inflows $ 4801477 4801477 Correct d. Calculate the net present value. (Do not round intermediate calculations. Round the final answer to nearest whole dollar.) Net present value $ Not attempted e. Should the Harding Corporation refund the old issue? Yes No

Answer 1

	a	Before tax Discount Rate	9%
		After tax discount rate	6.75%	(9*(1-0.25)		6.75
	b	Outflows:
	A	Total amount of Bond	$50,000,000
	B=A*(8-1.5)%	Call Premium	$3,250,000
	C=A*1.8%	Underwriting cost	$900,000
	D=B+C	Present Value of total outflows	$4,150,000
	c	Inflows:
	E=A*10.25%	Annual Coupon payment on old bond	$5,125,000
	F=A*9%	Annual Coupon payment on new issue	$4,500,000
	G=E-F	Annual Cash inflow(Before Tax)	$625,000
	Nper	Number of years of inflow	18
	Pmt=G*(1-0.25)	After tax Annual Cash inflow	$468,750
	Rate	Discount Rate	6.75%
	PV	Present value of total inflows	$4,801,477	(using PV function of excel with Rate=6.75%, Nper=18, Pmt=-468750)
	d	Net Present Value(NPV)
	NPV=PV-D	Net Present Value(NPV)	$651,477	(4801477-4150000)
	e	Yes, Harding Corporation should refund the old issue
		Because, NPV is positive