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Solution 12/8/2012
Chapter: 18
Problem: 8
Current bond issue data
Par value 70,000,000$
Coupon rate 10%
Original maturity 30
a. Perform a complete bond refunding analysis. What is the bond refunding's NPV?
Initial investment outlay to refund old issue:
Call premium on old issue = 7,000,000.00$
After-tax call premium = 4,200,000.00$
New flotation cost = 5,000,000.00$
Annual Flotation Cost Tax Effects:
Annual tax savings on new flotation = 90,909.09$
Tax savings lost on old flotation = 60,000.00$
Total amortization tax effects = 30,909.09$
Schumann Shoe Manufacturer is considering whether or not to refund a $70 million, 10% coupon, 30-year bond issue that was sold 8 years
ago. It is amortizing $4.5 million of flotation costs on the 10% bonds over the issue's 30-year life. Schumann's investment bankers have
indicated that the company could sell a new 22-year issue at an interest rate of 8 percent in today's market. Neither they nor Schumann's
management anticipate that interest rates will fall below 6 percent any time soon, but there is a chance that interest rates will increase.
A call premium of 10 percent would be required to retire the old bonds, and flotation costs on the new issue would amount to $5 million.
Schumann's marginal federal-plus-state tax rate is 40 percent. The new bonds would be issued 1 month before the old bonds are called,
with the proceeds being invested in short-term government securities returning 5 percent annually during the interim period.
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Use Goal Seek to set cell D60 to zero by changing cell C27.
