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Q16-17BP-b.

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Foundations Of Financial Management
Found in: Page 530
Foundations Of Financial Management

Foundations Of Financial Management

Book edition 16th
Author(s) Stanley B. Block, Geoffrey A. Hirt, Bartley Danielsen
Pages 768 pages
ISBN 9781259277160

Short Answer

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.

b. Calculate the present value of total inflows.

The present value of total inflows is $1,199,497.

See the step by step solution

Step by Step Solution

Step 1: Information provided in question

Bond obligation = 18,000,000

Interest rate at the time of issue = 10%

Interest rate after decline = 8.5%

Time = 20 years

Time remaining of bonds = 10 years

Call premium on old issue =9%

Underwriting cost of new issue =$530,000

Underwriting cost on old issue = $380,000

Discount rate = 8%

Tax rate = 35%

Step 2: Calculation of the present value of interest savings

The present value of interest savings is $1,177,619.

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

The present value of gain on the underwriting cost is $21,878.

Step 4: Calculation of present value of outflows

The present value of inflows is $1,199,497.

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