Question

Question: Problem 16-18 Refunding decision [LO16-3] The Robinson Corporation has $29 million of bonds outst... Problem 16-18 Refunding decision [LO16-3] The Robinson Corporation has $29 million of bonds outstanding that were issued at a coupon rate of 11.150 percent seven years ago. Interest rates have fallen to 10.650 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 2.90 percent of the total bond value. The underwriting cost on the new issue will be 1.90 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.)

Answer 1

		Interest rate for new bond	10.65%
		Underwriting cost for new bond	1.90%
		Before tax cost of debt	10.86%	(10.65/(100-1.9)*100%
		Afterb tax cost of debt =	7.60%	10.86*(1-Tax rate)=10.86*(1-0.3)
		Discount Rate	8%	(Rounded to whole number)
		OUTFLOWS:
		Call Premium =(7-(2*0.5))=	6%
		Total Call premium	$1,740,000	($29 million*6%)
		Underwriting Cost	$551,000	($29 million*1.9%)
		Total Cash Outflow	$2,291,000	(1740000+551000)
		Coupon Payment on old bond	$3,233,500	($29million*11.150%)
		Coupon Payment on NEW bond	$3,088,500	($29million*10.650%)
		Before tax savings	$145,000
	Pmt	After tax Annual savings	$101,500	(145000*(1-0.3)
	Nper	Number of years of savings	17
	Rate	Discount rate	8%
	PV	Present Value of Cash inflows	$925,846	(using PV function of excelwith Rate=8%, Nper=17, Pmt=-101500)
		ExcelCommand:PV(8%,17,-101500)
		Present Value of cash outflows	$2,291,000
		NET PRESENT VALUE	($1,365,154)	(925846-2291000)