Chapter 16: Long-Term Debt and Lease Financing
c. Maturity value $1,000.00
Calculator Solution:
(a)
N
I/Y
PV
PMT
10
5
CPT PV –961.39
45
1,000
Answer: 961.39
b. Purchase price $1,000.00
d. The percentage gain is larger than the percentage loss because the investment is
Chapter 16: Long-Term Debt and Lease Financing
Inflows
3. Cost savings in lower interest rates
16-17. (Continued)
4. Underwriting cost on old issue
Original amount $380,000
Amount written off over 10 years
at $19,000 per year 190,000
Inflows
Summary
Chapter 16: Long-Term Debt and Lease Financing
Outflows
Inflows
1.
$1,053,000
3.
$1,177,605
2.
405,529
4.
21,879
$1,458,529
$1,199,484
PV of inflows
$1,199,484
PV of outflows
1,458,529
Net present value
$ –259,045
Do not refund the old issue (particularly if it is perceived
that interest rates will go down even more).
Calculator solution:
Summary
Outflows
Inflows
1.
$1,053,000
3.
$1,174,264**
2.
405,528*
4.
21,878***
$1,458,528
$1,196,142
PV of inflows
$1,196,142
PV of outflows
1,458,528
Net present value
$ –262,386
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
10
8
CPT PV –
124,472.01
18,550
0
PV of future tax savings $124,472
Actual expenditure $530,000
PV of future tax savings 124,472
Net cost of underwriting expense on new issue $405,528
**Present value of future tax savings
N
I/Y
PV
PMT
10
8
CPT PV –
1,177,619.285
175,500
0
PV of future tax savings $1,177,619
Chapter 16: Long-Term Debt and Lease Financing
***Present value of deferred future write-off
N
I/Y
PV
PMT
10
8
CPT PV –
127,491.55
19,000
0
PV of deferred future write-off $127,492
Unamortized old underwriting cost $190,000
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
Chapter 16: Long-Term Debt and Lease Financing
Amount written off over last 7 years at
$43,000 per year ($1,032,000/24) × 7 301,000
16-18. (Continued)
Inflows
3. $2,745,722
4. 101,626
$2,847,348
Summary
Outflows
Inflows
1.
$2,558,500
3.
$2,745,722
2.
613,326
4.
101,626
$3,171,826
$2,847,348
PV of inflows
$2,847,348
PV of outflows
3,171,826
Net present value
$ –324,478
Based on the negative net present value, the Robinson
Corporation should not refund the issue. As time passes, the
Chapter 16: Long-Term Debt and Lease Financing
Calculator Solution:
Summary
Outflows
Inflows
1.
$2,558,500
3.
$2,745,613**
2.
613,331*
4.
101,631***
$3,171,831
$2,847,244
PV of Inflows
$2,847,244
PV of outflows
3,171,831
Net present value
$ -324,587
*Present value of future tax savings
N
I/Y
PV
PMT
17
8
CPT PV –
117,669.13
12,900
0
PV of future tax savings $117,669
**Present value of savings
N
I/Y
PV
PMT
17
8
CPT PV –
2,745,613.07
301,000
0
PV of future tax savings $2,745,613
***Present value of deferred future write-off:
Chapter 16: Long-Term Debt and Lease Financing
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?
16–19. Solution:
The Sunbelt Corporation
Outflows
1. Payment on call provision
$40,000,000 × 7.5% = $3,000,000
Chapter 16: Long-Term Debt and Lease Financing
16-19. (Continued)
Inflows
3. Cost savings in lower interest rates
12 7/8% (interest on old bond) × $40,000,000 = $5,150,000
4. Underwriting cost on old issue
Original amount (2.5% × $40,000,000) $1,000,000
Amount written off over last 7 years at
Chapter 16: Long-Term Debt and Lease Financing
Summary
Outflows
Inflows
1.
$1,920,000
3.
$2,099,328
2.
585,043
4.
124,243
$2,505,043
$2,223,571
PV of inflows
$2,223,571
PV of outflows
2,505,043
Net present value
$ (281,472)
Based on the negative net present value, the Sunbelt
Corporation should not refund the issue.
Calculator solution:
Summary
Outflows
Inflows
1.
$1,920,000
3.
$2,099,303**
2.
585,045*
4.
124,245***
$2,505,045
$2,223,548
PV of inflows
$2,223,548
PV of outflows
2,505,045
Net present value
$ (281,497)
Chapter 16: Long-Term Debt and Lease Financing
CPT PV –
*Present value of future tax savings
N
I/Y
PV
PMT
18
8
CPT PV –
134,955.17
14,400
0
**Present value of savings
N
I/Y
PV
PMT
18
8
CPT PV –
2,099,302.72
224,000
0
Chapter 16: Long-Term Debt and Lease Financing
21. Financial Statement effects of leases (LO16-4) The Harris Company is the lessee on a 4-year
lease with the following payments at the end of each year:
Year 1: $10,000
Year 2: $15,000
Year 3: $20,000
Year 4: $25,000
An appropriate discount rate is 7%, yielding a present value of $48,055.
a) If the lease is an operating lease
i. What will be the initial value of the right-of-use asset?
ii. What will be the initial value of the lease liability?
iii. What will be the lease expense shown on the income statement at the end of year
1?
iv. What will be the interest expense shown on the income statement at the end of
year 1?
v. What will be the amortization expense shown on the income statement at the end
of year 1?
b) If the lease is a finance lease
i. What will be the initial value of the right-of-use asset?
ii. What will be the initial value of the lease liability?
iii. What will be the lease expense shown on the income statement at the end of year
1?
iv. What will be the interest expense shown on the income statement at the end of
year 1?
v. What will be the amortization expense shown on the income statement at the end
of year 1?
16–21. Solution: