Question

The Bowman Corporation has a bond obligation of $21 million outstanding, which it is considering refunding. Though the bonds were initially issued at 10 percent, the interest rates on similar issues have declined to 8.7 percent. The bonds were originally issued for 20 years and have 10 years remaining. The new issue would be for 10 years. There is a 9 percent call premium on the old issue. The underwriting cost on the new $21,000,000 issue is $510,000, and the underwriting cost on the old issue was $400,000. The company is in a 35 percent tax bracket, and it will use an 10 percent discount rate to analyze the refunding decision. Use Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods.

a. Calculate the present value of total outflows. (Do not round intermediate calculations and round your answer to 2 decimal places.)
  

b. Calculate the present value of total inflows. (Do not round intermediate calculations and round your answer to 2 decimal places.)
  

c. Calculate the net present value. (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places.)
  

d. Should the old issue be refunded with new debt?
  

• Yes

• No

• I would like to add, that this question was previously answered incorrect, the answers were as follows: a. 380500 b. 11289302 c. 31322761 d. was answered as yes, but the correct answer is no. Please advise, ASAP! Thank You.

Answer 1

Bowman Corporation

I) Outflows

1.Payment of call premium

$21000000 × 9% = $1,890,000

$1,890,000 (1 – 0.35) = $1228500

2.Underwriting cost on new issue

Amortization of costs ($510,000/10) (.35)

$51,000 x (.35) = $17,850 tax savings per year

Actual expenditure $510,000

PV of future tax savings $17,850 × 6.145* $109,688

Net cost of underwriting expense on new issue $400,312

*PVIFA for n = 10, i = 10% (Appendix D)

II) Inflows

3.Cost savings in lower interest rates

10% (interest on old bond) × $21,000,000 = $ 2,100,000/year

8.7% (interest on new bond) × $21,000,000 = 1,827,000/year

Savings per year before taxes= $ Aftertax Savings $273,000 × (1 – .35) = $177,450 per yr.

$273,000 × 6.145* = $1,677,585 PVIFA(n = 10, i = 10%) (Appendix D).

4.Underwriting cost on old issue

Original amount $400,000

Amount written off over 5 years

at $20,000 per year ($100000)

Unamortized old underwriting cost $300,000

Present value of deferred future write-off

$20,000 × 6.145 (n = 10, I = 10%) $122,900

Immediate gain in old underwriting

cost write-off $177,100

Tax rate × 0.35

Aftertax value of immediate gain in old

Underwriting cost write-off $61,985

Summary

Outflows

1) $1,890,000 2) $400,312

Inflows

3) $1,677,585 4) $61,985

As outflow is more than the in flow it is not adviced to refund old issue with new Debt