Question 1

Cutech issued a $150 million of a 20-year, 10.5% debt 5 years ago. Since then, Cutech's financial conditions have improved and management believes that they could refund the old issue with a new 15-year, 7.5% issue. The old debt is now callable at 104 percent of par and issuance costs on the new issue would be 0.6 percent. The unamortized issuance costs on the old issue are $675,000. If Cutech calls the old issue and refunds it, both issues would be outstanding for a two-week period. If the company's marginal tax rate is 40%, should Cutech refund the old issue?

Accepted Answer

11ea10f6_a129_2a21_b6b3_819e120cde89_TB2040_00 PV of savings = $4.50(PVIFA_,045.15)=$48,328 million Call premium = $6(1-.4) = $3.6 million PV issuance = 900,000 - (900,000/15)(.4)(PVIFA,_045.15) =900,000 - 257,749 = $642,251 PV old issuance = (675,000/15)(.4)(PVIFA) - 675,000(.4) =193,312 - 270,000 = -$76,688 Overlapping int.= $150(.063)(2/52) = $363,462 Net investment = 3,600,000 + 642,251 - 76,688 + 363,462 = 4,529,025 NPV refunding = 48,328,000 - 4,529,025 = $43,798,975

Question 2

Midget Digit Toe Doctors is planning to refund a 30 year bond issue. They will replace $1,500,000 of 10.25% bonds with 6.25% bonds. The firm is in the 40% tax bracket. What is the savings on the refunding?

Accepted Answer

Solution:
 11ea10f6_a129_5132_b6b3_677e1b881717_TB2040_00 
Using a calculator:
N = 30
I = 6.25 * .6
Pmt = 36,250
PV = $646,310.14

Question 3

When considering bond refunding, all of the following are important input items EXCEPT:

Accepted Answer

While the weighted cost of capital, interest payments of old and new issues, and after-tax cost of debt are all important input items in bond refunding decisions, the only item listed that is not important is the weighted cost of capital.

Question 4

Clinch River Power is considering refunding a $150 million 12% coupon bond with a 10% coupon bond, 20 year bond. The current bond also matures in 20 years and is now callable at 110% of par. The unamortized flotation cost on the old issue is $540,000 and the flotation cost of the new issue is 0.925%. Clinch River estimates that there would be a 4 week period where both bonds would be outstanding. The company has a weighted cost of capital of 11% and a 40% marginal tax rate. Should Clinch River sell the refunding issue?

Accepted Answer

11ea10f6_a129_0310_b6b3_e15cd83f2eac_TB2040_00

Question 5

Wood River Power Company is considering refunding a $100 million 12% coupon debenture issue with a 9% coupon, 20-year debenture. The 12% issue also matures in 20 years and is now callable at 109% of par. The unamortized flotation cost on the old issue is $360,000 and the flotation cost of the new issue is 0.775%. Wood River estimated that there would be a 4 week period where both bonds would be outstanding. The company has a weighted cost of capital of 11% and a 40% marginal tax rate. Should Wood River sell the refunding issue? (Note: PVIFA_0.054,20= 12.050)

Accepted Answer

Solution:
Interest saved = $100(0.03)(0.6) = $1.8 million per year
PV interest saved = $1.8(12.050) = $21.69 million
A.T. call premium = $100(0.09)(0.6) = $5.4 million
PV flotation cost = $100(0.00775) - ($0.775/20)(0.4)(12.050) = $0.588 million
PV flotation, old issue = ($0.360/20)(0.4)12.050 - $0.360(0.4) = $0.0572 million
Overlapping interest after-tax = $100(0.072)(4/52) = $0.554 million
Net investment = $5.4 + $0.588 - $0.0572 + $0.554 = $6.485 million
NPV of refunding = $21.69 - $6.485 = $15.21 million

Question 6

In a bond refunding analysis, the principal benefit, or cash inflow, is the present value of the

Accepted Answer

The principal benefit or cash inflow in a bond refunding analysis is the aftertax interest savings over the life of the issue. This is because refunding involves issuing new bonds to pay off old bonds, which typically carry a higher interest rate. By refinancing at a lower interest rate, the company can save money on interest payments over the remaining life of the issue. The aftertax interest savings accounts for any tax implications of the refunding, making it the most accurate measure of the cash inflow generated by the refunding.

Question 7

If Alliant can issue a $110 million 20-year refunding bond at 7.45% and call an older $110 million issue with 20-years to maturity that had a coupon of 8.80%, what is the present value of the interest savings? Assume a 40% tax rate.

Accepted Answer

11ea10f6_a128_dbff_b6b3_8b056ed6cbe3_TB2040_00 PV = $891,000(PVIFA_.044.20) =$11,620,259 Solution using a financial calculator calculator N= 20 I = 7.45 * .6 Pmt = 891,000 PV = $11,620,259.03

Question 8

When a bond is called, the old issue is retired and the bondholder receives:

Accepted Answer

When a bond is called, the issuer typically pays off the bond's principal value plus any remaining interest to the bondholder. This is known as a cash payoff. A new issue of bonds or stock may be offered in the future, but it is not guaranteed and would be a separate transaction.

Question 9

Why is the after-tax cost of debt used in bond refunding analysis?

Accepted Answer

The answer of Why is the after-tax cost of debt...

Question 10

Demetres is refunding an outstanding $75 million, 9.35% debenture with a $75 million 7.80% debenture. Both issues will be outstanding for a 3-week period. If Demetres' marginal tax rate is 40%, what is the overlapping interest?

Accepted Answer

Solution:
Overlapping interest = $75(.0935)(.6)(3/52) = $242,740

Question 11

Bond ____ occurs when a firm exercises its option to redeem a callable bond issue and replaces it with a lower (interest) cost issue.

Accepted Answer

Refunding occurs when a firm exercises its option to redeem a callable bond issue and replaces it with a lower (interest) cost issue.

Question 12

Bond refunding occurs when a company redeems a callable issue and

Accepted Answer

Bond refunding refers to the process of redeeming a callable issue by selling a new issue with a lower coupon rate. This allows the company to pay off its debt at a lower cost, thereby reducing its interest expense. Option A is incorrect as selling an equity issue would not reduce outstanding debt, but instead increase the company's equity. Option C is also incorrect as selling a preferred issue with a low dividend rate would not necessarily reduce the company's interest expense. Option D is incorrect as one of the choices must be correct.

Question 13

In a bond refunding analysis, the net investment calculation includes

Accepted Answer

The net investment calculation in a bond refunding analysis includes all of the given options: aftertax call premium, flotation cost of new debt, and overlapping interest. The aftertax call premium is the cost of calling existing bonds, which must be subtracted from the proceeds of issuing new bonds. The flotation cost of new debt represents the costs associated with issuing new bonds, such as legal and underwriting fees. Finally, overlapping interest refers to the interest paid on the old bonds between the date of refunding and their call date. All of these factors must be considered to determine the net investment of a bond refunding.

Question 14

What is the principal inflow and what is the principal outflow from a bond refunding situation?

Accepted Answer

The answer of What is the principal inflow and what...

Question 15

In considering the bond refunding analysis, which of the following statements is/are correct?
I. The marginal rate of return is used as the discount rate
II. Bond refunding is most prevalent during a period of high inflation.

Accepted Answer

The marginal rate of return is not typically used as the discount rate in bond refunding analysis, and bond refunding is more common during periods of low interest rates, not high inflation.

Question 16

In bond refunding analysis the ____ is believed to be the most appropriate discount rate.

Accepted Answer

The answer of In bond refunding analysis the ____ is...

Question 17

If interest rates decline, a firm should consider _______________ to take advantage of the lower interest rates.

Accepted Answer

Bond refunding involves issuing new bonds to pay off existing bonds at a lower interest rate. This can help the firm to reduce its interest expenses and increase profitability. Selling fixed assets, investing in marketable securities, and stock sales may not directly benefit from lower interest rates.

Question 18

Why would a corporation consider bond refunding?

Accepted Answer

The answer of Why would a corporation consider bond refunding?...

Question 19

Waste Deep Disposal Services are considering refunding a $525,000,000 bond issue. The old bonds have a 7.25% coupon rate. The new bonds will have a 6% coupon rate. Both issues will be outstanding for about four weeks. What is the overlapping interest if the company is in the 38% tax bracket (rounded)?

Accepted Answer

525,000,000(.0725)(.62)(4/52) =$1,815,288.46

Quiz 27: Bond Refunding Analysis