Chapter 16, Problem 17P

a.

Summary Introduction

To calculate: The PV of total outflows of The Bowman Corporation.

Introduction:

Present value (PV):

The current value of an investment or an asset is termed as its present value. It is evaluated by discounting the future value of the investment or asset. 

Answer to Problem 17P

The PV of total outflow of The Bowman Corporation is $1,458,528.

Explanation of Solution

Calculation of PV of outflows:

$\begin{array}{c}\text{Present Value of Outflows}=\text{Payment of call premium}+\text{Underwriting cost of new issue}\\ =\$1,053,000+\$405,528\\ =\$1,458,528\end{array}$

Working Notes:

Calculation of payment of call premium:

$\begin{array}{c}\text{Payment of call premium}=\text{New issue}\times \left(1-\text{Tax rate}\right)\times \text{call premium percentage}\\ =\text{\$18,000,000}\times \left(1-0.35\right)\times 9\%\\ =\text{\$18,000,000}\times 0.65\times 9\%\\ =\$1,053,000\end{array}$

Calculation of tax saving per year:

$\begin{array}{c}\text{Tax saving per year}=\frac{\text{Actual Expenditure}}{\text{Remaining years for bond maturity}}\times \text{Tax Rate}\\ =\frac{\$530,000}{10}\times \$0.35\\ =\$18,550\end{array}$

The calculation of current price of bond, that is, PV of future tax savings is shown below.

The formula used for the calculation of current price of bond, that is, PV of future tax savings is shown below.

Calculation of underwriting cost of new issue:

$\begin{array}{c}\text{Underwriting cost of new issue}=\text{Actual expenditure}-\text{PV of future tax savings}\\ =\$530,000-\$124,472\\ =\$405,528\end{array}$

b.

Summary Introduction

To calculate: The PV of the total inflow of The Bowman Corporation.

Introduction:

Present value (PV):

The current value of an investment or an asset is termed as its present value. It is evaluated by discounting the future value of the investment or asset. 

Answer to Problem 17P

The PV of the total inflow of Bowman Corporation is $1,199,484.

Explanation of Solution

Calculation of PV of inflows:

$\begin{array}{c}\text{Present Value of inflows}=\text{Present value of future tax savings}+\text{Underwriting cost write off}\\ =\$1,177,619+\$21,878\\ =\$1,199,497\end{array}$

Working Notes:

The calculation of PV of future tax savings is shown below.

The formula used for the calculation of PV of future tax savings is shown below.

The calculation of PV of deferred future write off is shown below.

The formula used for the calculation of PV of deferred future write off is shown below.

Calculation of gain in old underwriting cost write-off:

$\begin{array}{c}\text{Gain in old underwriting cost write off}=\text{Unamortized old underwriting cost}-\\ \text{PV of deferred future write off}\\ =\$190,000-\$127,492\\ =\$62,508\end{array}$

Calculation of Underwriting cost write-off:

$\begin{array}{c}\text{Underwriting cost write off}=\text{Gain in old underwriting cost write off}\times \text{Tax rate}\\ =\$62,508\times 0.35\\ =\$21,878\end{array}$

c.

Summary Introduction

To calculate: The NPV of The Bowman Corporation.

Introduction:

Net present value (NPV) profile:

A project’s NPV profile is the representation done graphically of the project’s NPV corresponding to different values of the rate of discount. It shows the changes that take place in NPV as a result of the changes in the cost of capital.

Answer to Problem 17P

The NPV of The Bowman Corporation is ($259,045).

Explanation of Solution

Calculation of NPV:

$\begin{array}{c}\text{Net Present Value}=\text{Present Value of inflows}-\text{Present Value of outflows}\\ =\$1,199,484-\$1,458,529\\ =-\$259,045\end{array}$

d.

Summary Introduction

To determine: Whether the old issue shall be refunded with The Bowman Corporation’s new debt.

Introduction:

Present value (PV):

The current value of an investment or an asset is termed as its present value. It is evaluated by discounting the future value of the investment or asset. 

Answer to Problem 17P

No, the old issue of The Bowman Corporation shall not be refunded.

Explanation of Solution

The Bowman’s Corporation’s old issue shall not be refunded, especially if there exists a chance that the rate of interest will further go down, as the NPV calculated in part (c) is negative.