Problem 16-17 Refunding decision [LO3] The Bowman Corporation has a bond obligat
ID: 2744755 • Letter: P
Question
Problem 16-17 Refunding decision [LO3] The Bowman Corporation has a bond obligation of $24 million outstanding, which it is considering refunding. Though the bonds were initially issued at 13 percent, the interest rates on similar issues have declined to 11.7 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 call premium of 9 percent on the old issue. The underwriting cost on the new $24,000,000 issue is $540,000, and the underwriting cost on the old issue was $430,000. The company is in a 35 percent tax bracket, and it will use an 12 percent discount rate (rounded aftertax cost of debt) to analyze the refunding decision. Calculate your final answer using the formula and financial calculator methods.
a. Calculate the present value of total outflows. (Do not round intermediate calculations and round your answer to 2 decimal places.)
PV of total outflows $
b. Calculate the present value of total inflows. (Do not round intermediate calculations and round your answer to 2 decimal places.)
PV of total inflows $
c. 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.)
Net present value $
d. Should the old issue be refunded with new debt? Yes No
Explanation / Answer
Bond obligation $24,000,000 Interest rate on bonds 13.00% Interest rate on new bonds 11.70% Call premium 9.00% Tax rate 35.00% Underwriting costs of new issue $540,000 Underwriting costs of old issue $430,000 Years remaining on bonds 10 Discount rate 12.00% a. Outflows 1) After tax cost of call = Bond Obligation x Call Premium x (1-taxrate) After Tax Cost of Call = $24,000,000 x 9% x (1-35%) $1,404,000 2) Underwriting cost on new issue Actual expenditure $540,000 Amortization of Costs = Actual expenditure / years remaining= $540,000/10 $54,000 Present value of future tax savings = $54,000 x 35% x PVIFA(12%,10) = $54000 x 35% x 5.6502 $106,788.78 Net cost of underwriting expense ($540,000 - $106,788.78) $433,211.22 b.Inflows 3)Cost savings in lower interest rates: Interest on old bonds = $240,000,000 x 13% $3,120,000 Interest on new bonds = $24,000,000 x 11.7% $2,808,000 Savings per year before taxes $312,000 Aftertax Savings per year = $312,000 x (1-35%) $202,800 Present value of savings = $202,800 x PVIFA(12%,10)= $202,800 x 5.6502) $1,145,860.56 4)Underwriting cost on old issue Original amount $430,000 Amount written off over 10 years = ($430,000/20) x10 $215,000 Unamortized old underwriting cost($430,000-$215,000) $215,000 Less: Present value of deferred future write-off($430,000/20)*PVIFA(12%,10) $121,479.3 Immediate gain in old underwriting cost write-off $93,520.7 After-tax value of immediate gain in old underwriting cost write-off = $93,520.7 x 35% $32,732.25 Present Value of Inflows =($1,145,860.56 + $32,732.25) $1,178,592.81 Less: Present Value of Outflows =($1,404,000 + $433,211.22) $1,837,211.22 Net Present Value -$658,618.42 yes,Refund the old issue with new debt