Sui Bian Ltd. has a callable outstanding bond issue with a face value of $5 million, which was issued ten years ago at flotation cost 5% of the face value. The bond has 10 years remaining to the maturity date and a coupon rate of 12% paid annually. The call premium of the old bonds is 50% of the annual coupon rate. Interest rates at the time of the issue were considerably higher than they are now and the company would now like to refinance the bonds. The new bonds of 10-year maturity could be issued at a coupon rate of 8% paid annually. The call premium of the new bonds is 60% of the annual coupon rate. The flotation costs associated with the new bond issue are 4% of the face value. The new bonds would be issued one month before the old bonds could be called. Firm's corporate tax rate is 35%. The current T-Bill rate is 3%. Note: Don't forget the minus sign for the negative cash flows! 1. What is the annual after-tax cost of debt? 2. What is the incremental after-tax interest savings from the refinancing? 3. What is the value of the call premium associated with the old issue of bonds?
Sui Bian Ltd. has a callable outstanding bond issue with a face value of $5 million, which was issued ten years ago at flotation cost 5% of the face value. The bond has 10 years remaining to the maturity date and a coupon rate of 12% paid annually. The call premium of the old bonds is 50% of the annual coupon rate. Interest rates at the time of the issue were considerably higher than they are now and the company would now like to refinance the bonds. The new bonds of 10-year maturity could be issued at a coupon rate of 8% paid annually. The call premium of the new bonds is 60% of the annual coupon rate. The flotation costs associated with the new bond issue are 4% of the face value. The new bonds would be issued one month before the old bonds could be called. Firm's corporate tax rate is 35%. The current T-Bill rate is 3%. Note: Don't forget the minus sign for the negative cash flows! 1. What is the annual after-tax cost of debt? 2. What is the incremental after-tax interest savings from the refinancing? 3. What is the value of the call premium associated with the old issue of bonds?
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text:Sui Bian Ltd. has a callable outstanding bond issue with a face value of $5 million, which was issued
ten years ago at flotation cost 5% of the face value. The bond has 10 years remaining to the maturity
date and a coupon rate of 12% paid annually. The call premium of the old bonds is 50% of the
annual coupon rate.
Interest rates at the time of the issue were considerably higher than they are now and the company
would now like to refinance the bonds. The new bonds of 10-year maturity could be issued at a
coupon rate of 8% paid annually. The call premium of the new bonds is 60% of the annual coupon
rate. The flotation costs associated with the new bond issue are 4% of the face value.
The new bonds would be issued one month before the old bonds could be called. Firm's corporate
tax rate is 35%. The current T-Bill rate is 3%.
Note: Don't forget the minus sign for the negative cash flows!
1. What is the annual after-tax cost of debt?
2. What is the incremental after-tax interest savings from the refinancing?
3. What is the value of the call premium associated with the old issue of bonds?
4. What is the net flotation costs associated with the new issue of bonds, i.e. the difference
between the total flotation cost and the present value of the tax savings from the flotation costs?
5. What is net additional interest expense during the overlap period?
6. What is the NPV of the refund the old bonds and issue new bonds ?
3.
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