978-1259277160 Chapter 16 Solution Manual Part 3

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16-16. Solution:

Mr. Robinson – Mrs. Pinson

a. Present value of interest payments

Present value of principal payment at maturity

Total present value

d. The percentage gain is larger than the percentage loss because

Calculator Solution:

(a)

N I/Y PV PMT FV

Answer: 961.39

Dollar loss/Investment = $38.61/$1,000 = 3.86%

d. The percentage gain is larger than the percentage loss because the investment is

17. Advanced refunding decision (LO16-3) The Bowman Corporation has a $18 million

bond obligation outstanding, which it is considering refunding. Though the bonds were

initially issued at 10 percent, the interest rates on similar issues have declined to 8.5

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 $18,000,000 issue is $530,000, and the underwriting cost on

the old issue was $380,000. The company is in a 35 percent tax bracket, and it will use an 8

percent discount rate (rounded aftertax cost of debt) to analyze the refunding decision.

a. Calculate the present value of total outflows.

b. Calculate the present value of total inflows.

c. Calculate the net present value.

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

16-17. Solution:

Bowman Corporation

Outflows

1. Payment of call premium

2. Underwriting cost on new issue

*PVIFA for n = 10, i = 8% (Appendix D)

Outflows

Inflows

3. Cost savings in lower interest rates

16-17. (Continued)

4. Underwriting cost on old issue

Inflows

Summary

Outflows Inflows

Do not refund the old issue (particularly if it is perceived that

interest rates will go down even more).

Calculator solution:

Summary

Outflows Inflows

Do not refund the old issue (particularly if it is perceived that interest rates will go

down even more).

*Present value of future tax savings

N I/Y PV PMT FV

PV of future tax savings $124,472

**Present value of future tax savings

N I/Y PV PMT FV

PV of future tax savings $1,177,619

***Present value of deferred future write-off

N I/Y PV PMT FV

PV of deferred future write-off $127,492

18. Refunding decision (LO16-3) The Robinson Corporation has $43 million of bonds

outstanding that were issued at a coupon rate of 11¾ percent seven years ago. Interest rates

have fallen to 10¾ 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 2.4 percent of the total bond value. The underwriting cost on the new issue will be 1.7

percent of the total bond value. The original bond indenture contained a five-year

protection against a call, with a 9 percent call premium 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.) Assume the discount rate is equal

to the aftertax cost of new debt rounded up to the nearest whole number.

a. Compute the discount rate.

b. Calculate the present value of total outflows.

c. Calculate the present value of total inflows.

d. Calculate the net present value.

16-18. Solution:

Robinson Corporation

First compute the discount rate

Outflows

1. Payment on call provision (7th year = 8.5% call premium)

2. Underwriting cost on new issue

*PVIFA for n = 17, i = 8% (Appendix D)

Outflows

16-18. (Continued)

Inflows

3. Cost savings in lower interest rates

Savings per year $430,000 × (1 – 0.3) = $301,000 Aftertax

4. Underwriting cost on old issue

Aftertax value of immediate gain in old

16-18. (Continued)

Inflows

Summary

Outflows Inflows

Based on the negative net present value, the Robinson

Calculator Solution:

Summary

Outflows Inflows

*Present value of future tax savings

N I/Y PV PMT FV

PV of future tax savings $117,669

**Present value of savings

N I/Y PV PMT FV

PV of future tax savings $2,745,613

***Present value of deferred future write-off:

N I/Y PV PMT FV

PV of deferred future write-off $392,230

19. Call premium (LO16-3) The Sunbelt Corporation has $40 million of bonds outstanding

that were issued at a coupon rate of 12⅞ percent seven years ago. Interest rates have fallen

to 12 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 2.5

percent of the total bond value. The underwriting cost on the new issue will be 1.8 percent

of the total bond value. The original bond indenture contained a five-year protection against

a call, with an 8 percent call premium 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). Assume the discount rate is equal to the aftertax cost of new

debt rounded up to the nearest whole number. Should the Sunbelt Corporation refund the

old issue?