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Chapter 5: 6DQ (page 471)
Do corporations rely more on external or internal funds as sources of financing?
Corporations rely more on external funds than internal as sources of financing.
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Question: The Bowman Corporation has a \(18 million bond obligation outstanding, which it is considering refunding. Though the bonds were initially issued at 10 percent, the interest rates on similar issues have declined to 8.5 percent. The bonds were originally issued for 20 years and have 10 years remaining. The new issue would be for 10 years. There is a 9 percent call premium on the old issue. The underwriting cost on the new \)18,000,000 issue is \(530,000, and the underwriting cost on the old issue was \)380,000. The company is in a 35 percent tax bracket, and it will use an 8 percent discount rate (rounded after-tax cost of debt) to analyze the refunding decision.
a. Calculate the present value of total outflows.
Preston Corporation has a bond outstanding with an \(80 annual interest payment, a market price of \)1,250, and a maturity date in 10 years. Assume the par value of the bonds is $1,000. Find the following:
a.The coupon rate.
b.The current rate.
c.The yield to maturity.
The Robinson Corporation has $43 million of bonds outstanding that were issued at a coupon rate of 11戮 percent seven years ago. Interest rates have fallen to 10戮 percent. Mr. Brooks, the vice president of finance, does not expect rates to fall any further. The bonds have 17 years left to maturity, and Mr. Brooks would like to refund the bonds with a new issue of an equal amount also having 17 years to maturity. The Robinson Corporation has a tax rate of 30 percent. The underwriting cost on the old issue was 2.4 percent of the total bond value. The underwriting cost on the new issue will be 1.7 percent of the total bond value. The original bond indenture contained five-year protection against a call, with a 9 percent call premium 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.) Assume the discount rate is equal to the after-tax cost of new debt rounded up to the nearest whole number.
c. Calculate the present value of total inflows.
The Hamilton Corporation Company has 4 million shares of stock outstanding and will report earnings of \(6,910,000 in the current year. The company is considering the issuance of 1 million additional shares that can only be issued at \)30 per share.
a. Assume that Hamilton Corporation Company can earn 7.0 percent on the proceeds. Calculate the earnings per share.
b. Should the new issue be undertaken based on earnings per share?
Harold Reese must choose between two bonds: Bond X pays \(95 annual interest and has a market value of \)900. It has 10 years to maturity. Bond Zpays \(95 annual interest and has a market value of \)920. It has two years tomaturity.
a.Compute the current yield on both bonds.
b.Which bond should he select based on your answer to part a?
c.A drawback of current yield is that it does not consider the total life of thebond. For example, the yield to maturity on Bond X is 11.21 percent. Whatis the yield to maturity on Bond Z?
d.Has your answer changed between parts band cof this question?
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