The Bowman Corporation has a band obligasion of 25 milition

The Bowman Corporation has a band obligasion of $25 milition outstanding, which it is considering refunding. Though the bonds were initially issued at 10 percent, the interest rates on similar issues have declined to 8.7 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 oid issue. The underwniting cost on the new $25 O issue is $550,000, and the under rit g cost on the old issue was $440 000 The company ?. 35 percent tax bracket, and it wq use an 11 percent disc unt rate rounded ate tax cost of debt to analyze the refunding dedision. Use Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods a. Caloulate the present value of total outflows (Do not round Intermediate calculations and round your answer to 2 declmal places) of total outows b. Calculate the present value of total infiows (Do not round Intermediate calculations and round your answer to 2 decimal places.) Py of sotal ouftows 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.) present value d. Should the old issue be refunded with new debr? ?Yos O No

Solution

a) Net Cost of Call Premium: (Call premium rate × Face value of issue) × (1 – Tax rate)

                                           =0.09 *(25,000,000) *(1-0.35)

                                          = 1,462,500.00

Underwriting Cost of New Issue: 550,000

Annual Tax Saving New Issue : (Underwriting cost _{New issue} / Issue years) × Tax rate

                                                = 550,000/10*0.35

                                                 =19,250

PV of Tax Saving New Issue = 19250*(1-(1/1.11)^10))/(0.11)

=113,367.72

PV of Cash Outflows: Net Cost of Call Premium+ Underwriting Cost of New Issue – PV of Tax Saving New Issue

=1,462,500.00 +550,000 -113,367.72 = 1,899,132.28

b) Net annual interest savings: (Initial interest rate – Current interest rate) × Face value of issue × (1 – Tax rate)

= (0.10-0.087)* 25000000*(1-0.35)

=211,250.00

PV of interest savings = 211250*(1-(1/1.11)^10))/(0.11)

                                      =1,244,100.26

Annual Amortization Old Issue:       Underwriting cost Old Issue / Issue years

                                                  = 440,000/20

                                                 = 22,000.00

Unamortized Cost of Old Issue = Cost of Old Issue – (Annual Amortization * Number of years since issuance)

=440,000-(22000*10)

=220,000

PV of Unamortized Cost of Old Issue = 22000*1-(1/1.11)^10))/(0.11)

                                                        =129,563.10

Tax Saving on Old Issue : (220,000-129,563.10)* (0.35) =31,652.92

PV of Cash Inflows : PV of Interest Savings + Tax Savings on Old Issue

                                   =1,244,100.26 +31652.92

                                   =1,275,753.18

c) Net Present Value = PV of Cash Inflows - PV of Cash Outflows

                              =1,275,753.18 - 1,899,132.28

                              = -623,379.10

d) No since net present value is negative old issue should not be refunded.

PV of Tax Saving New Issue = 19250*(1-(1/1.11)^10))/(0.11) =113,367.72 PV of Cash Outflows: Net Cost of Call Premium+ Underwriting Cost of New Issue – PV of Tax Saving New Issue =1,462,500.00 +550,000 -113,367.72 = 1,899,132.28