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Multiple Choice
1. In a bond refunding analysis, the principal benefit, or cash inflow, is the present value of the ____.
a.
pre-tax interest savings over the life of the issue
b.
after-tax flotation cost savings
c.
after-tax interest savings over the life of the issue
d.
after-tax call premium
c
2. In a bond refunding analysis, the net investment calculation includes ____.
a.
after-tax call premium
b.
flotation cost of new debt
c.
overlapping interest
d.
All of these are correct
d
3. Bond refunding occurs when a company redeems a callable issue and sells a(n) ____.
a.
equity issue, thereby reducing outstanding debt
b.
lower-cost issue
c.
preferred issue with a low dividend rate
d.
None of these are correct
b
4. In bond refunding analysis the ____ is believed to be the most appropriate discount rate.
a.
after-tax cost of new debt
b.
firm’s marginal cost of capital
c.
weighted average cost of capital
d.
All of these are correct
a
5. Bond ____ occurs when a firm exercises its option to redeem a callable bond issue and replaces it with a lower
(interest) cost issue.
a.
redemption
b.
retirement
c.
recall
d.
refunding
d
6. If Alliant can issue a $110 million 20-year refunding bond at 7.45% and call an older $110 million issue with 20 years
to maturity that had a coupon of 8.80%, what is the present value of the interest savings? Assume a 40% tax rate.
a.
$11,620,259
b.
$17,820,000
c.
$ 9,117,935
d.
$29,561,100
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a
7. Demetres is refunding an outstanding $75 million, 9.35% debenture with a $75 million 7.80% debenture. Both issues
will be outstanding for a 3-week period. If Demetres’ marginal tax rate is 40%, what is the overlapping interest?
a.
$337,500
b.
$242,740
c.
$404,567
d.
$202,500
b
8. Wood River Power Company is considering refunding a $100 million 12% coupon debenture issue with a 9% coupon,
20-year debenture. The 12% issue also matures in 20 years and is now callable at 109% of par. The unamortized flotation
cost on the old issue is $360,000, and the flotation cost of the new issue is 0.775%. Wood River estimated that there
would be a 4-week period where both bonds would be outstanding. The company has a weighted cost of capital of 11%
and a 40% marginal tax rate. Should Wood River sell the refunding issue? Why or why not? (Note: PVIFA0.054,20 =
12.050)
a.
Yes; NPV is approximately $15.21 million
b.
Yes; NPV is approximately $9.86
c.
Yes; NPV is approximately 6.485 million
d.
No; NPV is negative $0.554 million
a
9. Clinch River Power is considering refunding a $150 million 12% coupon bond with a 10% coupon bond, 20-year bond.
The current bond also matures in 20 years and is now callable at 110% of par. The unamortized flotation cost on the old
issue is $540,000, and the flotation cost of the new issue is 0.925%. Clinch River estimates that there would be a 4-week
period where both bonds would be outstanding. The company has a weighted cost of capital of 11% and a 40% marginal
tax rate. Clinch River has decided to sell the refunding issue. What is their reasoning?
a.
NPV is approximately $9.838 million
b.
NPV is approximately $9.930 million
c.
NPV is approximately $9.655 million
d.
NPV is approximately $10.808 million
a
10. Cutech issued a $150 million of a 20-year, 10.5% debt 5 years ago. Since then, Cutech’s financial condition has
improved and management believes that it could refund the old issue with a new 15-year, 7.5% issue. The old debt is now
callable at 104% of par, and issuance costs on the new issue would be 0.6%. The unamortized issuance costs on the old
issue are $675,000. If Cutech calls the old issue and refunds it, both issues would be outstanding for a two-week period. If
the company’s marginal tax rate is 40%, should Cutech refund the old issue? Why or why not?
a.
Yes; NPV = $43,645,599
b.
Yes; NPV = $43,798,975
c.
Yes; NPV = $44,364,538
d.
No; NPV is negative
b
11. In considering the bond refunding analysis, which of the following statements is (are) correct?
I. The marginal rate of return is used as the discount rate.
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II. Bond refunding is most prevalent during a period of high inflation.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements I and II are correct.
d.
Neither statement I nor II is correct.
d
12. Waste Deep Disposal Services is considering refunding a $525,000,000 bond issue. The old bonds have a 7.25%
coupon rate. The new bonds will have a 6% coupon rate. Both issues will be outstanding for about four weeks. What is the
overlapping interest if the company is in the 38% tax bracket (rounded)?
a.
$1,517,465
b.
$1,815,288
c.
$1,357,642
d.
$1,225,427
b
13. Midget Digit Toe Doctors is planning to refund a 30-year bond issue. It will replace $1,500,000 of 10.25% bonds with
6.25% bonds. The firm is in the 40% tax bracket. What is the savings on the refunding?
a.
$515,100
b.
$646,310
c.
$725,600
d.
$815,170
b
14. If interest rates decline, a firm should consider ____ to take advantage of the lower interest rates.
a.
selling fixed assets
b.
stock sales
c.
bond refunding
d.
investing in marketable securities
c
15. When considering bond refunding, all except which of the following are important input items?
a.
Interest payments of old issue
b.
Weighted cost of capital
c.
Interest payments of new issue
d.
After-tax cost of debt
b
16. When a bond is called, the old issue is retired and the bondholder receives ____.
a.
new, lower interest rate bonds
b.
new corporate stock
c.
a cash payoff
d.
treasury stock
c
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Essay
17. Why would a corporation consider bond refunding?
18. What is the principal inflow and what is the principal outflow from a bond refunding situation?
19. Why is the after-tax cost of debt used in bond refunding analysis?