Please help...I will rate asap. Thank you in advance The Sunbelt Corporation has
ID: 2653690 • Letter: P
Question
Please help...I will rate asap. Thank you in advance
The Sunbelt Corporation has $39 million of bonds outstanding that were issued at a coupon rate of 11.675 percent seven years ago. Interest rates have fallen to 11.20 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 2.6 percent of the total bond value. The underwriting cost on the new issue will be 1.4 percent of the total bond value. The original bond indenture contained a five-year protection against a call, with a call premium of 8 percent 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). Use Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods. Assume the discount rate is equal to the aftertax cost of new debt rounded up to the nearest whole percent (e.g. 4.06 percent should be rounded up to 5 percent).
Compute the discount rate. (Do not round intermediate calculations. Input your answer as a percent rounded up to the nearest whole percent.)
Calculate the present value of total outflows. (Do not round intermediate calculations and round your answer to 2 decimal places.)
Calculate the present value of total inflows. (Do not round intermediate calculations and round your answer to 2 decimal places.)
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.)
Should the Sunbelt Corporation refund the old issue?
Please help...I will rate asap. Thank you in advance
The Sunbelt Corporation has $39 million of bonds outstanding that were issued at a coupon rate of 11.675 percent seven years ago. Interest rates have fallen to 11.20 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 2.6 percent of the total bond value. The underwriting cost on the new issue will be 1.4 percent of the total bond value. The original bond indenture contained a five-year protection against a call, with a call premium of 8 percent 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). Use Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods. Assume the discount rate is equal to the aftertax cost of new debt rounded up to the nearest whole percent (e.g. 4.06 percent should be rounded up to 5 percent).
Explanation / Answer
Answer: (a)
First compute the discount rate
11.20% (1 – .36) = 11.20% × .64 = 7.168%. or round up to 8%
Answer:(b) Outflows
1. Payment on call provision
$39,000,000 × 7.5% = $2925,000
$2925,000 (1 – .36) = $1872,000
2. Underwriting cost on new issue
Actual expenditure 1.4% × $39,000,000 = $546,000
Amortization of costs ($546,000/18) =30333.333
Tax savings per year = $30333.33 (.36) =$10920
Actual expenditure $546000
PV of future tax savings $ 10920 × 9.372* 102342.24
Net cost of underwriting expense on new issue $443657.76
*PVIFA for n = 18, i = 8% (Appendix D)
Answer:(c) Inflows
3. Cost savings in lower interest rates
11.675% (interest on old bond) ×$39,000,000 = $4553250
11.20% (interest on new bond) × $39,000,000 = 4,368000
Savings per year $ 185250
Savings per year $185250 × (1 – .36) = $118560Aftertax
$ 118560
× 9.372 PVIFA (n = 18, i = 8%) Appendix D
$1111144.32 Present value of savings
4. Underwriting cost on old issue
Original amount (2.6% × $39,000,000) $1,014,000
Amount written off over last 7 years at
$40560 per year ($1,014,000/25) × 7 283920
Unamortized old underwriting cost $ 730080
Present value of deferred future write off:
$40,560 × 9.372 (n = 18, i = 8%) 380128.32
Immediate gain in old underwriting write-off $ 349951.68
Tax rate × .36
Aftertax value of immediate gain in old
underwriting cost write-off $ 125982.60
Answer:(D)
Summary
Outflows
Inflows
1.
$1872,000
3.
$1111144.32
2.
$443657.76
4.
$ 125982.60
$2315657.76
$1237126.92
PV of inflows
$1237126.92
PV of outflows
$2315657.76
Net present value
$ (1078530.84)
Answer:(e) Based on the negative net present value, the Sunbelt Corporation should not refund the issue.
Answer:(D)
Summary
Outflows
Inflows
1.
$1872,000
3.
$1111144.32
2.
$443657.76
4.
$ 125982.60
$2315657.76
$1237126.92
PV of inflows
$1237126.92
PV of outflows
$2315657.76
Net present value
$ (1078530.84)