Question

The Sunbelt Corporation has $35 million of bonds outstanding that were issued at a coupon rate of 11.275 percent seven years ago. Interest rates have fallen to 10.75 percent. Mr. Heath, the Vice-President of Finance, does not expect rates to fall any further. The bonds have 18 years left to maturity, and Mr. Heath would like to refund the bonds with a new issue of equal amount also having 18 years to maturity. The Sunbelt Corporation has a tax rate of 36 percent. The underwriting cost on the old issue was 2.2 percent of the total bond value. The underwriting cost on the new issue will be 1.2 percent of the total bond value. The original bond indenture contained a five-year protection against a call, with a call premium of 7 percent 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.) b. Calculate the present value of total outflows. (Do not round intermediate calculations and round your answer to 2 decimal places.) c. Calculate the present value of total inflows. (Do not round intermediate calculations and round your answer to 2 decimal places.) d. 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.) e. Should the Sunbelt Corporation refund the old issue? Yes No

Answer 1

	a	CALCULATION OF DISCOUNT RATE
		Assume face value per Bond	$1,000
		Underwriting cost	$12.0	(1000*1.2%)
		Net amount received	$988.0
		Coupon payment	$107.50	(1000*10.75%)
		Before tax cost of debt	10.90%	(Using RATE Function of excelwith Nper=18,Pmt=107.5,Pv=-988, Fv=1000,)
		Tax Rate	36%
		After tax cost of debt	6.979%	(10.9*(1-0.36)
		Discount Rate	7%	(Rounded to whole number)
		Outflows:
		Call Premium =(7-2*0.5)=6%
		Amount of Call Premium	$2,100,000	(35million *6%)
		Underwriting Cost	$420,000	(35 bmillion *1.2%)
	A	Present value of Total Cash outflow	$2,520,000
		INFLOWS:
		Coupon Payment per year if the Bonds are not called	$3,946,250	(35million*11.275%)
		Coupon Payment per year with the new issue	$3,762,500	(35million*10.75%)
		Inflow per year	$183,750
	Pmt	After tax inflow per year =183750*(1-0.36)=	$117,600
	Nper	Number of years of inflow	18
	Rate	Discount Rate	7%
	PV	Present Value of Total Cash inflow	$1,182,948.62	(Using PV Function of excel with Nper=18,Rate=7%,Pmt=-117600)
	PV-A	Net Present Value=(Inflow-outflow)	($1,337,051.38)
		Should the Sunbelt Corporation refund the old issue?
		ANSWER: NO
		Because Net Present value is negative