ond Refunding. Fara Corporation is considering calling a P20 million, 30-year bond that was issued 10 years ago at a face interest rate of 14 percent. The call price on the bonds is 104. The bonds were initially sold at 97. The initial flotation cost was P200,000. The company is considering issuing P20 million, 12 percent, 20-year bonds in order to net proceeds and retire the old bonds. The new bonds will be issued at face value. The flotation costs for the new issue are P225,000. The tax rate is 46 percent. The after-tax cost of new debt ignoring flotation costs is 6.48 percent (12% x 54%). With flotation costs, the after-tax cost of new debt is anticipated to be 7 percent. There is a 2-month overlap in which interest must be paid on the old bonds and new bonds. Should refunding take place?
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
Bond Refunding.
Fara Corporation is considering calling a P20 million, 30-year bond that was issued 10 years ago at a face interest rate of 14 percent. The call price on the bonds is 104. The bonds were initially sold at 97. The initial flotation cost was P200,000. The company is considering issuing P20 million, 12 percent, 20-year bonds in order to net proceeds and retire the old bonds. The new bonds will be issued at face value. The flotation costs for the new issue are P225,000. The tax rate is 46 percent. The after-tax cost of new debt ignoring flotation costs is 6.48 percent (12% x 54%). With flotation costs, the after-tax cost of new debt is anticipated to be 7 percent. There is a 2-month overlap in which interest must be paid on the old bonds and new bonds. Should refunding take place?
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