Question

The Bowman Corporation has a bond obligation of $16 million outstanding, which it is considering refunding. Though the bonds were initially issued at 13 percent, the interest rates on similar issues have declined to 11.8 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 call premium of 9 percent on the old issue. The underwriting cost on the new $16,000,000 issue is $460,000, and the underwriting cost on the old issue was $350,000. The company is in a 35 percent tax bracket, and it will use an 10 percent discount rate (rounded aftertax cost of debt) 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 to 2 decimal places

PV of total outflows_____________

B. Calculate the present value of total inflows to 2 decimal places

PV of total outflows __________________

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.)

NPV ______________

D. should the old issue be refunded with new debt?

yes or no

Answer 1

		Present Value of outflows:
		Bond outstanding	$16,000,000
		Call premium (9%)	$1,440,000
		Underwriting cost	$460,000
	A	Present Value of total outflows:	$17,900,000
		Current coupon payment per year	$2,080,000	(16000000*13%)
		Coupon Payment for new issue per year	$1,888,000	(16000000*11.8%)
		Saving in coupon payment per year	$192,000
	Pmt	Annual After Tax Savings =192000*(1-Tax Rate)	$124,800
	Nper	Number of years of savings	10
	Rate	After tax cost of debt =11.8*(1-0.35)	7.67%
	PV	Present Value of after tax savings	$850,027.27	(Using PV function of excel with Rate=7.67%, Nper=10,Pmt=-124800)
		Excel Command: PV(7.67%,10,-124800)
		Present Value of Inflows:
		Cash from new issue	$16,000,000
		Present Value of annual savings	$850,027.27
	B	Present Value of total Inflows:	$16,850,027.27
	C	Net Present value=	($1,049,972.73)	(16850027.27-17900000)
	D	No, old issue should not be refunded with new debt