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Chapter 5: Q18BP-c (page 530)

Question: 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 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 a 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.

Short Answer

Expert verified

Answer

The present value of total inflows is $2,847,348.

Step by step solution

01

Information available

Bond obligation = 43,000,000

Interest rate at the time of issue = 11戮%

Interest rate after decline = 10戮%

Time remaining of bonds = 17 years

Call premium on old issue =9%

Underwriting cost of new issue =1.7% of total bond value

Underwriting cost on old issue = 2.4% of total bond value

Tax rate = 30%

Discount rate = 8%

02

 Step 2: Calculation of the present value of interest savings

The present value of interest savings is $2,745,722.

03

 Step 3: Calculation of present value of gain on underwriting cost

The present value of gain on the underwriting cost is $101,626.

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Most popular questions from this chapter

A \(1,000 par value bond was issued 25 years ago at a 12 percent coupon rate. It currently has 15 years remaining to maturity. Interest rates on similar obligations are now 8 percent.

a. What is the current price of the bond? (Look up the answer in Table 16-2.)

b. Assume Ms. Bright bought the bond three years ago when it had a price of \)1,050. What is her dollar profit based on the bond鈥檚 current price?

c. Further assume Ms. Bright paid 30 percent of the purchase price in cash and borrowed the rest (known as buying on margin). She used the interest payments from the bond to cover the interest costs on the loan. How much of the purchase price of $1,050 did Ms. Bright pay in cash?

d. What is Ms. Bright鈥檚 percentage return on her cash investment? Divide the answer to part b by the answer to part c.

e. Explain why her return is so high.

Question: I. B. Michaels has a chance to participate in a new public offering by Hi-Tech Micro Computers. His broker informs him that demand for the 700,000 shares to be issued is very strong. His broker鈥檚 firm is assigned 25,000 shares in the distribution and will allow Michaels, a relatively good customer, 1.3 percent of its 25,000-share allocation. The initial offering price is \(30 per share. There is a strong aftermarket, and the stock goes to \)32 one week after issue. The first full month after issue, Mr. Michaels is pleased to observe his shares are selling for \(33.50. He is content to place his shares in a lockbox and eventually use their anticipated increased value to help send his son to college many years in the future. However, one year after the distribution, he looks up the shares in The Wall Street Journal and finds they are trading at \)28.50.

a. Compute the total dollar profit or loss on Mr. Michaels鈥檚 shares one week, one month, and one year after the purchase. In each case, compute the profit or loss against the initial purchase price.

In what way is an investment banker a risk taker?

What is the difference between a bond agreement and a bond indenture? (LO16-1)

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.
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