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. Current bond issue data Par value $ 70,000,000 Coupon rate 10% Original maturity 30 Remaining maturity 22 Original flotation costs $ 4,500,000 Call premium 10% Tax rate 40% Refunding data Coupon rate 8.0000% Maturity 22 Flotation costs $ 5,000,000 Time between issuing new bonds and calling old bonds (months) 1 Rate earned on proceeds of new bonds before calling old bonds (annual) 5% 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 = After-tax call premium = New flotation cost = Old flotation costs already expensed = Remaining flotation costs to expense = Tax savings from old flotation costs = You get to expense the remaining flotation costs Additional interest on old issue after tax = This is interest paid on the old bond issue between when the new bonds are issued and the old bonds are retired Interest earned on investment in T-bonds after tax = This is interest earned on the proceeds from the new bonds before they are used to pay off the old bonds. Total investment outlay = Annual Flotation Cost Tax Effects: Annual tax savings on new flotation = Tax savings lost on old flotation = Total amortization tax effects = Annual interest savings due to refunding: Annual after tax interest on old bond = Annual after tax interest on new bond = Net after tax interest savings = Annual cash flows = After-tax cost of new debt = NPV of refunding decision = b. At what interest rate on the new debt is the NPV of the refunding no longer positive? Use Goal Seek to set cell D60 to zero by changing cell C27. "Break-even" interest rate =

Question

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.             Current bond issue data         Par value   $ 70,000,000       Coupon rate   10%       Original maturity   30       Remaining maturity   22       Original flotation costs  $ 4,500,000       Call premium   10%       Tax rate   40%                 Refunding data          Coupon rate   8.0000%       Maturity    22       Flotation costs   $ 5,000,000       Time between issuing new bonds and calling old bonds (months) 1       Rate earned on proceeds of new bonds before calling old bonds (annual) 5%                 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 =         After-tax call premium =         New flotation cost =         Old flotation costs already expensed =        Remaining flotation costs to expense =        Tax savings from old flotation costs =  You get to expense the remaining flotation costs   Additional interest on old issue after tax =  This is interest paid on the old bond issue between when the new bonds are issued and the old bonds are retired   Interest earned on investment in T-bonds after tax =  This is interest earned on the proceeds from the new bonds before they are used to pay off the old bonds.   Total investment outlay =                   Annual Flotation Cost Tax Effects:         Annual tax savings on new flotation =        Tax savings lost on old flotation =         Total amortization tax effects =                   Annual interest savings due to refunding:        Annual after tax interest on old bond =        Annual after tax interest on new bond =        Net after tax interest savings =                   Annual cash flows =                   After-tax cost of new debt =                   NPV of refunding decision =                   b. At what interest rate on the new debt is the NPV of the refunding no longer positive?                Use Goal Seek to set cell D60 to zero by changing cell C27.                    "Break-even" interest rate =

Unlock all answers

Related questions

Weekly leaderboard