Question

The Wagner Corporation has a $20 million bond obligation outstanding, which it is considering refunding. Though the bonds were initially issued at 16 percent, the interest rates on similar issues have declined to 13.3 percent. The bonds were originally issued for 20 years and have 16 years remaining. The new issue would be for 16 years. There is a 9 percent call premium on the old issue. The underwriting cost on the new $20 million issue is $550,000, and the underwriting cost on the old issue was $400,000. The company is in a 40 percent tax bracket, and it will allow an overlap period of one month (1/12 of the year). Treasury bills currently yield 5 percent. (Do not round intermediate calculations. Enter the answers in whole dollars, not in millions. Round the final answers to nearest whole dollar.)

 

a. Calculate the present value of total outflows.

 

Total outflows           $ 

 

b. Calculate the present value of total inflows.

 

Total inflows           $ 

 

c. Calculate the net present value.

 

Net present value           $ 

 

d. Should the old issue be refunded with new debt?

  

multiple choice

• Yes

• No

Answer 1

NPV of refunding decision = Total cash outflow for refund - Present value of annual cash inflows

Present value of annual cash inflows = Annual cash inflows/(1+yield on Treasury bills)^{maturity of new issue}

Annual cash inflows = Total amortization tax effects + Net after tax interest savings

a. Present value of total outflows is $1,612,000.

b. Present value of total inflows is $3,573,755.

c. net present value is $1,961,755.

d. Yes, the old issue should be refunded with new debt because net present value is positive.

formula for Present value of total inflows is: "=PV(0.05,16,-329750,0)"

$20,000,000 16% 20 1 Current bond issue information 2 Par value 3 coupon rate 4 original maturity 5 remaining maturity 6 original flotation costs 7 Call premium 8 Tax rate 16 $400,000 9% 40% 13.3% 16 10 New bond issue information 11 Coupon rate 12 maturity 13 flotation costs 14 15 Time between issues (months) 16 rate on surplus funds (annual) $550,000 5%

А в 18 Cash outflow to refund old issue: 19 Call premium on old issue 20 After-tax call premium 21 New flotation cost 22 Old flotation costs already expensed 23 Remaining flotation costs to expense 24 Tax savings from old flotation costs 25 Additional interest on old issue after tax 26 Interest earned on investment in T-bonds after tax 27 Total cash outflow for refund J K Formula $1,800,000 =C3C8 $1,080,000 =D20*(1-09) $550,000 =C14 $80,000 =(07/05)*(C5-C6) $320,000 =C7-D23 $128,000 =D24*C9 Remaining flotation costs need to be expensed $160,000 =C3*64*(C16/12)*(1-c9) Interest paid on old issue for 1 month period between the new and old issue $50,000 =C3*C17*(C16/12)*(1-C9) Interest received on proceeds from new issue before they are used to pay for old issue $1,612,000 =D21+D22-D25+D26-D27 28 29 Annual Flotation Cost Tax Effects: 30 Annual tax savings on new flotation 31 Tax savings lost on old flotation 32 Total amortization tax effects $13,750 =C14*09/013 $8,000 =C7*09/05 $5,750 =D31-D32 34 Annual interest savings due to refunding: 35 Annual after tax interest on old bond 36 Annual after tax interest on new bond 37 Net after tax interest savings $1,920,000 =C3*C4*(1-09) $1,596,000 =C3*C12*(1-09) $324,000 =D36-D37 38 39 Annual cash flows $329,750 =D33+D38

41 NPV of refunding decision $1,961,755 --D28-PV(C17, C13,D40,0)