The total dollar call premium required to call the old issue, whether it is tax deductible and the net after-tax cost of the call.

Question

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Answer 1

Question

Chapter 18, Problem 6P

a)

Summary Introduction

To determine: The total dollar call premium required to call the old issue, whether it is tax deductible and the net after-tax cost of the call.

a)

Expert Solution

Explanation of Solution

The overall premium is 0.11($40,000,000)=$4,400,000, since the call premium is 11 per cent. This is a tax deductible expense, though, so the actual after-tax expense is $4,400,000(1−T)=$4,400,000(1−0.4)=$2,640,000.

b)

Summary Introduction

To determine: The dollar floatation cost and whether it is immediately tax deductible and post-tax flotation cost.

b)

Expert Solution

Explanation of Solution

On the new issue the currency flotation rate is 0.04($40,000,000)=$1,600,000. The expense is not tax-deductible immediately and therefore the after-tax payment is $1,600,000, too. (Note that the flotation costs may be prorated and charged over the lifetime of the issue. The value of this tax savings shall be computed in Part e.).

c)

Summary Introduction

To determine: The amounts of old issue floatation cost and not been expensed and whether these deferred costs be expensed immediately if the old issue is refunded and the value of tax savings.

c)

Expert Solution

Explanation of Solution

On the old issue the flotation costs were 0.06($40,000,000)=$2,400,000. These costs have been postponed and are expensed over the issue's 25-year life, and thus $2,400,00025=$96,000 is spent annually, or $48,000 every 6 months. If the question is reimbursed, the unexpended part of the cost of the flotation can be expended immediately, resulting in tax savings of T($1,920,000)=0.40($1,920,000)=$768,000.

d)

Summary Introduction

To determine: The net post-tax cash outlay needed to refund the old issue.

d)

Expert Solution

Explanation of Solution

INTERMEDIATE FINANCIAL MANAGEMENT, Chapter 18, Problem 6P , additional homework tip 1

e)

Summary Introduction

To determine: The semiannual tax savings that arises from amortizing the floatation cost and the foregone semiannual tax savings on the old-issue floatation cost.

e)

Expert Solution

Explanation of Solution

The $1,600,000 cost of new issue flotation would be depreciated over the issue's 20-year existence. Therefore, it would cost $1,600,00020=$80,000 every year, or $40,000 every six months. The tax savings from this tax deduction are (0.40×$40,000)=$16,000 per half-year. By reimbursing the old issue and spending the surviving old issue flotation costs instantly, the company forgoes the opportunity to continue spending on the old flotation costs over time. In total, $2,400,00025=$96,000 annually, or $48,000 semi-annually. The forgone value for every $48,000 deduction is 0.40($48,000)=$19,200.

f)

Summary Introduction

To determine: The semiannually post-tax interest savings that would result from the refunding.

f)

Expert Solution

Explanation of Solution

The interest on the old issue is 0.11($40,000,000)=$4,400,000 per annum, or $2,200,000 per term. Since interest payments are tax deductible the semi-annual after-tax balance is 0.6($2,200,000)=$1,320,000. The new issue bears a coupon rate of 8 percent. The annual interest would therefore be 0.08($40,000,000)=$3,200,000, or $1,600,000 semi-annually. Therefore the after-tax cost is 0.6($1,600,000)=$960,000. Thus, after-tax net interest savings would be $1,320,000 or $960,000 = $360,000 semi-annually if reimbursement takes place.

g)

Summary Introduction

To determine: The sum of these two semiannual cash flows and appropriate discount rate to apply to these two semiannual cash flows and the present value.

g)

Expert Solution

Explanation of Solution

The estimated amortization tax benefits over 20 years are about $3,200 per year, while the net interest costs over 20 years are about $360,000 per year. The net semi-annual cash balance, as shown below, is thus $356,800.

INTERMEDIATE FINANCIAL MANAGEMENT, Chapter 18, Problem 6P , additional homework tip 2

The cash flows are predicated on treaty obligations and therefore have about the same level of risk as to the debt of the company. In fact, the cash flows are already tax-net. Consequently, the suitable interest rate is the after-tax cost of debt to GST.(The citation of the cash to fund the net investment expenditure also affects the discount rate, but most companies use debt to finance that expenditure, and in this case, the discount rate should be the after-tax debt cost.)Finally, as we are valuing future flows, the correct debt cost is the cost of today, or the cost of the new issue, and not the debt cost that floated five years ago. The appropriate rate of discount is thus 0.6(8 percent) = 4.8 percent per annum, or 2.4 percent per semi-annual period.

h)

Summary Introduction

To determine: The NPV of refunding and whether the GST refund now or wait until later.

h)

Expert Solution

Explanation of Solution

The redemption of bonds would entail a net cash outlay of $3,472,000, but on a present-value basis it would yield $9,109,413 in net savings. The refunding NPV is thus $5,637,413:

INTERMEDIATE FINANCIAL MANAGEMENT, Chapter 18, Problem 6P , additional homework tip 3

The choice to repay instead of wait until later is much harder than finding the refunding NPV now. If interest rates were expected to fall, and therefore GST could issue debt below today's 8 percent rate in the future, then it might pay to wait. Interest rate motions, however, are very difficult to predict, if not impossible, and thus most financial managers would likely take the "bird-in - the-hand" and reimburse with such a large NPV now. Remember, however, that if the NPV were quite low, say $1,000, management would certainly have been waiting, hoping interest rates would fall lower, and waiting costs ($1,000) wouldn't have been large enough to think about.

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Answer 2

Question

Chapter 18, Problem 6P

a)

Summary Introduction

To determine: The total dollar call premium required to call the old issue, whether it is tax deductible and the net after-tax cost of the call.

a)

Expert Solution

Explanation of Solution

The overall premium is 0.11($40,000,000)=$4,400,000, since the call premium is 11 per cent. This is a tax deductible expense, though, so the actual after-tax expense is $4,400,000(1−T)=$4,400,000(1−0.4)=$2,640,000.

b)

Summary Introduction

To determine: The dollar floatation cost and whether it is immediately tax deductible and post-tax flotation cost.

b)

Expert Solution

Explanation of Solution

On the new issue the currency flotation rate is 0.04($40,000,000)=$1,600,000. The expense is not tax-deductible immediately and therefore the after-tax payment is $1,600,000, too. (Note that the flotation costs may be prorated and charged over the lifetime of the issue. The value of this tax savings shall be computed in Part e.).

c)

Summary Introduction

To determine: The amounts of old issue floatation cost and not been expensed and whether these deferred costs be expensed immediately if the old issue is refunded and the value of tax savings.

c)

Expert Solution

Explanation of Solution

On the old issue the flotation costs were 0.06($40,000,000)=$2,400,000. These costs have been postponed and are expensed over the issue's 25-year life, and thus $2,400,00025=$96,000 is spent annually, or $48,000 every 6 months. If the question is reimbursed, the unexpended part of the cost of the flotation can be expended immediately, resulting in tax savings of T($1,920,000)=0.40($1,920,000)=$768,000.

d)

Summary Introduction

To determine: The net post-tax cash outlay needed to refund the old issue.

d)

Expert Solution

Explanation of Solution

INTERMEDIATE FINANCIAL MANAGEMENT, Chapter 18, Problem 6P , additional homework tip 1

e)

Summary Introduction

To determine: The semiannual tax savings that arises from amortizing the floatation cost and the foregone semiannual tax savings on the old-issue floatation cost.

e)

Expert Solution

Explanation of Solution

The $1,600,000 cost of new issue flotation would be depreciated over the issue's 20-year existence. Therefore, it would cost $1,600,00020=$80,000 every year, or $40,000 every six months. The tax savings from this tax deduction are (0.40×$40,000)=$16,000 per half-year. By reimbursing the old issue and spending the surviving old issue flotation costs instantly, the company forgoes the opportunity to continue spending on the old flotation costs over time. In total, $2,400,00025=$96,000 annually, or $48,000 semi-annually. The forgone value for every $48,000 deduction is 0.40($48,000)=$19,200.

f)

Summary Introduction

To determine: The semiannually post-tax interest savings that would result from the refunding.

f)

Expert Solution

Explanation of Solution

The interest on the old issue is 0.11($40,000,000)=$4,400,000 per annum, or $2,200,000 per term. Since interest payments are tax deductible the semi-annual after-tax balance is 0.6($2,200,000)=$1,320,000. The new issue bears a coupon rate of 8 percent. The annual interest would therefore be 0.08($40,000,000)=$3,200,000, or $1,600,000 semi-annually. Therefore the after-tax cost is 0.6($1,600,000)=$960,000. Thus, after-tax net interest savings would be $1,320,000 or $960,000 = $360,000 semi-annually if reimbursement takes place.

g)

Summary Introduction

To determine: The sum of these two semiannual cash flows and appropriate discount rate to apply to these two semiannual cash flows and the present value.

g)

Expert Solution

Explanation of Solution

The estimated amortization tax benefits over 20 years are about $3,200 per year, while the net interest costs over 20 years are about $360,000 per year. The net semi-annual cash balance, as shown below, is thus $356,800.

INTERMEDIATE FINANCIAL MANAGEMENT, Chapter 18, Problem 6P , additional homework tip 2

The cash flows are predicated on treaty obligations and therefore have about the same level of risk as to the debt of the company. In fact, the cash flows are already tax-net. Consequently, the suitable interest rate is the after-tax cost of debt to GST.(The citation of the cash to fund the net investment expenditure also affects the discount rate, but most companies use debt to finance that expenditure, and in this case, the discount rate should be the after-tax debt cost.)Finally, as we are valuing future flows, the correct debt cost is the cost of today, or the cost of the new issue, and not the debt cost that floated five years ago. The appropriate rate of discount is thus 0.6(8 percent) = 4.8 percent per annum, or 2.4 percent per semi-annual period.

h)

Summary Introduction

To determine: The NPV of refunding and whether the GST refund now or wait until later.

h)

Expert Solution

Explanation of Solution

The redemption of bonds would entail a net cash outlay of $3,472,000, but on a present-value basis it would yield $9,109,413 in net savings. The refunding NPV is thus $5,637,413:

INTERMEDIATE FINANCIAL MANAGEMENT, Chapter 18, Problem 6P , additional homework tip 3

The choice to repay instead of wait until later is much harder than finding the refunding NPV now. If interest rates were expected to fall, and therefore GST could issue debt below today's 8 percent rate in the future, then it might pay to wait. Interest rate motions, however, are very difficult to predict, if not impossible, and thus most financial managers would likely take the "bird-in - the-hand" and reimburse with such a large NPV now. Remember, however, that if the NPV were quite low, say $1,000, management would certainly have been waiting, hoping interest rates would fall lower, and waiting costs ($1,000) wouldn't have been large enough to think about.

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Subscribe now to access step-by-step solutions to millions of textbook problems written by subject matter experts!

Answer 3

Question

Chapter 18, Problem 6P

a)

Summary Introduction

To determine: The total dollar call premium required to call the old issue, whether it is tax deductible and the net after-tax cost of the call.

a)

Expert Solution

Explanation of Solution

The overall premium is 0.11($40,000,000)=$4,400,000, since the call premium is 11 per cent. This is a tax deductible expense, though, so the actual after-tax expense is $4,400,000(1−T)=$4,400,000(1−0.4)=$2,640,000.

b)

Summary Introduction

To determine: The dollar floatation cost and whether it is immediately tax deductible and post-tax flotation cost.

b)

Expert Solution

Explanation of Solution

On the new issue the currency flotation rate is 0.04($40,000,000)=$1,600,000. The expense is not tax-deductible immediately and therefore the after-tax payment is $1,600,000, too. (Note that the flotation costs may be prorated and charged over the lifetime of the issue. The value of this tax savings shall be computed in Part e.).

c)

Summary Introduction

To determine: The amounts of old issue floatation cost and not been expensed and whether these deferred costs be expensed immediately if the old issue is refunded and the value of tax savings.

c)

Expert Solution

Explanation of Solution

On the old issue the flotation costs were 0.06($40,000,000)=$2,400,000. These costs have been postponed and are expensed over the issue's 25-year life, and thus $2,400,00025=$96,000 is spent annually, or $48,000 every 6 months. If the question is reimbursed, the unexpended part of the cost of the flotation can be expended immediately, resulting in tax savings of T($1,920,000)=0.40($1,920,000)=$768,000.

d)

Summary Introduction

To determine: The net post-tax cash outlay needed to refund the old issue.

d)

Expert Solution

Explanation of Solution

INTERMEDIATE FINANCIAL MANAGEMENT, Chapter 18, Problem 6P , additional homework tip 1

e)

Summary Introduction

To determine: The semiannual tax savings that arises from amortizing the floatation cost and the foregone semiannual tax savings on the old-issue floatation cost.

e)

Expert Solution

Explanation of Solution

The $1,600,000 cost of new issue flotation would be depreciated over the issue's 20-year existence. Therefore, it would cost $1,600,00020=$80,000 every year, or $40,000 every six months. The tax savings from this tax deduction are (0.40×$40,000)=$16,000 per half-year. By reimbursing the old issue and spending the surviving old issue flotation costs instantly, the company forgoes the opportunity to continue spending on the old flotation costs over time. In total, $2,400,00025=$96,000 annually, or $48,000 semi-annually. The forgone value for every $48,000 deduction is 0.40($48,000)=$19,200.

f)

Summary Introduction

To determine: The semiannually post-tax interest savings that would result from the refunding.

f)

Expert Solution

Explanation of Solution

The interest on the old issue is 0.11($40,000,000)=$4,400,000 per annum, or $2,200,000 per term. Since interest payments are tax deductible the semi-annual after-tax balance is 0.6($2,200,000)=$1,320,000. The new issue bears a coupon rate of 8 percent. The annual interest would therefore be 0.08($40,000,000)=$3,200,000, or $1,600,000 semi-annually. Therefore the after-tax cost is 0.6($1,600,000)=$960,000. Thus, after-tax net interest savings would be $1,320,000 or $960,000 = $360,000 semi-annually if reimbursement takes place.

g)

Summary Introduction

To determine: The sum of these two semiannual cash flows and appropriate discount rate to apply to these two semiannual cash flows and the present value.

g)

Expert Solution

Explanation of Solution

The estimated amortization tax benefits over 20 years are about $3,200 per year, while the net interest costs over 20 years are about $360,000 per year. The net semi-annual cash balance, as shown below, is thus $356,800.

INTERMEDIATE FINANCIAL MANAGEMENT, Chapter 18, Problem 6P , additional homework tip 2

The cash flows are predicated on treaty obligations and therefore have about the same level of risk as to the debt of the company. In fact, the cash flows are already tax-net. Consequently, the suitable interest rate is the after-tax cost of debt to GST.(The citation of the cash to fund the net investment expenditure also affects the discount rate, but most companies use debt to finance that expenditure, and in this case, the discount rate should be the after-tax debt cost.)Finally, as we are valuing future flows, the correct debt cost is the cost of today, or the cost of the new issue, and not the debt cost that floated five years ago. The appropriate rate of discount is thus 0.6(8 percent) = 4.8 percent per annum, or 2.4 percent per semi-annual period.

h)

Summary Introduction

To determine: The NPV of refunding and whether the GST refund now or wait until later.

h)

Expert Solution

Explanation of Solution

The redemption of bonds would entail a net cash outlay of $3,472,000, but on a present-value basis it would yield $9,109,413 in net savings. The refunding NPV is thus $5,637,413:

INTERMEDIATE FINANCIAL MANAGEMENT, Chapter 18, Problem 6P , additional homework tip 3

The choice to repay instead of wait until later is much harder than finding the refunding NPV now. If interest rates were expected to fall, and therefore GST could issue debt below today's 8 percent rate in the future, then it might pay to wait. Interest rate motions, however, are very difficult to predict, if not impossible, and thus most financial managers would likely take the "bird-in - the-hand" and reimburse with such a large NPV now. Remember, however, that if the NPV were quite low, say $1,000, management would certainly have been waiting, hoping interest rates would fall lower, and waiting costs ($1,000) wouldn't have been large enough to think about.

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Subscribe now to access step-by-step solutions to millions of textbook problems written by subject matter experts!

Answer 4

Question

Chapter 18, Problem 6P

a)

Summary Introduction

To determine: The total dollar call premium required to call the old issue, whether it is tax deductible and the net after-tax cost of the call.

a)

Expert Solution

Explanation of Solution

The overall premium is 0.11($40,000,000)=$4,400,000, since the call premium is 11 per cent. This is a tax deductible expense, though, so the actual after-tax expense is $4,400,000(1−T)=$4,400,000(1−0.4)=$2,640,000.

b)

Summary Introduction

To determine: The dollar floatation cost and whether it is immediately tax deductible and post-tax flotation cost.

b)

Expert Solution

Explanation of Solution

On the new issue the currency flotation rate is 0.04($40,000,000)=$1,600,000. The expense is not tax-deductible immediately and therefore the after-tax payment is $1,600,000, too. (Note that the flotation costs may be prorated and charged over the lifetime of the issue. The value of this tax savings shall be computed in Part e.).

c)

Summary Introduction

To determine: The amounts of old issue floatation cost and not been expensed and whether these deferred costs be expensed immediately if the old issue is refunded and the value of tax savings.

c)

Expert Solution

Explanation of Solution

On the old issue the flotation costs were 0.06($40,000,000)=$2,400,000. These costs have been postponed and are expensed over the issue's 25-year life, and thus $2,400,00025=$96,000 is spent annually, or $48,000 every 6 months. If the question is reimbursed, the unexpended part of the cost of the flotation can be expended immediately, resulting in tax savings of T($1,920,000)=0.40($1,920,000)=$768,000.

d)

Summary Introduction

To determine: The net post-tax cash outlay needed to refund the old issue.

d)

Expert Solution

Explanation of Solution

INTERMEDIATE FINANCIAL MANAGEMENT, Chapter 18, Problem 6P , additional homework tip 1

e)

Summary Introduction

To determine: The semiannual tax savings that arises from amortizing the floatation cost and the foregone semiannual tax savings on the old-issue floatation cost.

e)

Expert Solution

Explanation of Solution

The $1,600,000 cost of new issue flotation would be depreciated over the issue's 20-year existence. Therefore, it would cost $1,600,00020=$80,000 every year, or $40,000 every six months. The tax savings from this tax deduction are (0.40×$40,000)=$16,000 per half-year. By reimbursing the old issue and spending the surviving old issue flotation costs instantly, the company forgoes the opportunity to continue spending on the old flotation costs over time. In total, $2,400,00025=$96,000 annually, or $48,000 semi-annually. The forgone value for every $48,000 deduction is 0.40($48,000)=$19,200.

f)

Summary Introduction

To determine: The semiannually post-tax interest savings that would result from the refunding.

f)

Expert Solution

Explanation of Solution

The interest on the old issue is 0.11($40,000,000)=$4,400,000 per annum, or $2,200,000 per term. Since interest payments are tax deductible the semi-annual after-tax balance is 0.6($2,200,000)=$1,320,000. The new issue bears a coupon rate of 8 percent. The annual interest would therefore be 0.08($40,000,000)=$3,200,000, or $1,600,000 semi-annually. Therefore the after-tax cost is 0.6($1,600,000)=$960,000. Thus, after-tax net interest savings would be $1,320,000 or $960,000 = $360,000 semi-annually if reimbursement takes place.

g)

Summary Introduction

To determine: The sum of these two semiannual cash flows and appropriate discount rate to apply to these two semiannual cash flows and the present value.

g)

Expert Solution

Explanation of Solution

The estimated amortization tax benefits over 20 years are about $3,200 per year, while the net interest costs over 20 years are about $360,000 per year. The net semi-annual cash balance, as shown below, is thus $356,800.

INTERMEDIATE FINANCIAL MANAGEMENT, Chapter 18, Problem 6P , additional homework tip 2

The cash flows are predicated on treaty obligations and therefore have about the same level of risk as to the debt of the company. In fact, the cash flows are already tax-net. Consequently, the suitable interest rate is the after-tax cost of debt to GST.(The citation of the cash to fund the net investment expenditure also affects the discount rate, but most companies use debt to finance that expenditure, and in this case, the discount rate should be the after-tax debt cost.)Finally, as we are valuing future flows, the correct debt cost is the cost of today, or the cost of the new issue, and not the debt cost that floated five years ago. The appropriate rate of discount is thus 0.6(8 percent) = 4.8 percent per annum, or 2.4 percent per semi-annual period.

h)

Summary Introduction

To determine: The NPV of refunding and whether the GST refund now or wait until later.

h)

Expert Solution

Explanation of Solution

The redemption of bonds would entail a net cash outlay of $3,472,000, but on a present-value basis it would yield $9,109,413 in net savings. The refunding NPV is thus $5,637,413:

INTERMEDIATE FINANCIAL MANAGEMENT, Chapter 18, Problem 6P , additional homework tip 3

The choice to repay instead of wait until later is much harder than finding the refunding NPV now. If interest rates were expected to fall, and therefore GST could issue debt below today's 8 percent rate in the future, then it might pay to wait. Interest rate motions, however, are very difficult to predict, if not impossible, and thus most financial managers would likely take the "bird-in - the-hand" and reimburse with such a large NPV now. Remember, however, that if the NPV were quite low, say $1,000, management would certainly have been waiting, hoping interest rates would fall lower, and waiting costs ($1,000) wouldn't have been large enough to think about.

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Answer 5

Chapter 18, Problem 6P

a)

Summary Introduction

To determine: The total dollar call premium required to call the old issue, whether it is tax deductible and the net after-tax cost of the call.

a)

Expert Solution

Explanation of Solution

The overall premium is 0.11($40,000,000)=$4,400,000, since the call premium is 11 per cent. This is a tax deductible expense, though, so the actual after-tax expense is $4,400,000(1−T)=$4,400,000(1−0.4)=$2,640,000.

b)

Summary Introduction

To determine: The dollar floatation cost and whether it is immediately tax deductible and post-tax flotation cost.

b)

Expert Solution

Explanation of Solution

On the new issue the currency flotation rate is 0.04($40,000,000)=$1,600,000. The expense is not tax-deductible immediately and therefore the after-tax payment is $1,600,000, too. (Note that the flotation costs may be prorated and charged over the lifetime of the issue. The value of this tax savings shall be computed in Part e.).

c)

Summary Introduction

To determine: The amounts of old issue floatation cost and not been expensed and whether these deferred costs be expensed immediately if the old issue is refunded and the value of tax savings.

c)

Expert Solution

Explanation of Solution

On the old issue the flotation costs were 0.06($40,000,000)=$2,400,000. These costs have been postponed and are expensed over the issue's 25-year life, and thus $2,400,00025=$96,000 is spent annually, or $48,000 every 6 months. If the question is reimbursed, the unexpended part of the cost of the flotation can be expended immediately, resulting in tax savings of T($1,920,000)=0.40($1,920,000)=$768,000.

d)

Summary Introduction

To determine: The net post-tax cash outlay needed to refund the old issue.

d)

Expert Solution

Explanation of Solution

INTERMEDIATE FINANCIAL MANAGEMENT, Chapter 18, Problem 6P , additional homework tip 1

e)

Summary Introduction

To determine: The semiannual tax savings that arises from amortizing the floatation cost and the foregone semiannual tax savings on the old-issue floatation cost.

e)

Expert Solution

Explanation of Solution

The $1,600,000 cost of new issue flotation would be depreciated over the issue's 20-year existence. Therefore, it would cost $1,600,00020=$80,000 every year, or $40,000 every six months. The tax savings from this tax deduction are (0.40×$40,000)=$16,000 per half-year. By reimbursing the old issue and spending the surviving old issue flotation costs instantly, the company forgoes the opportunity to continue spending on the old flotation costs over time. In total, $2,400,00025=$96,000 annually, or $48,000 semi-annually. The forgone value for every $48,000 deduction is 0.40($48,000)=$19,200.

f)

Summary Introduction

To determine: The semiannually post-tax interest savings that would result from the refunding.

f)

Expert Solution

Explanation of Solution

The interest on the old issue is 0.11($40,000,000)=$4,400,000 per annum, or $2,200,000 per term. Since interest payments are tax deductible the semi-annual after-tax balance is 0.6($2,200,000)=$1,320,000. The new issue bears a coupon rate of 8 percent. The annual interest would therefore be 0.08($40,000,000)=$3,200,000, or $1,600,000 semi-annually. Therefore the after-tax cost is 0.6($1,600,000)=$960,000. Thus, after-tax net interest savings would be $1,320,000 or $960,000 = $360,000 semi-annually if reimbursement takes place.

g)

Summary Introduction

To determine: The sum of these two semiannual cash flows and appropriate discount rate to apply to these two semiannual cash flows and the present value.

g)

Expert Solution

Explanation of Solution

The estimated amortization tax benefits over 20 years are about $3,200 per year, while the net interest costs over 20 years are about $360,000 per year. The net semi-annual cash balance, as shown below, is thus $356,800.

INTERMEDIATE FINANCIAL MANAGEMENT, Chapter 18, Problem 6P , additional homework tip 2

The cash flows are predicated on treaty obligations and therefore have about the same level of risk as to the debt of the company. In fact, the cash flows are already tax-net. Consequently, the suitable interest rate is the after-tax cost of debt to GST.(The citation of the cash to fund the net investment expenditure also affects the discount rate, but most companies use debt to finance that expenditure, and in this case, the discount rate should be the after-tax debt cost.)Finally, as we are valuing future flows, the correct debt cost is the cost of today, or the cost of the new issue, and not the debt cost that floated five years ago. The appropriate rate of discount is thus 0.6(8 percent) = 4.8 percent per annum, or 2.4 percent per semi-annual period.

h)

Summary Introduction

To determine: The NPV of refunding and whether the GST refund now or wait until later.

h)

Expert Solution

Explanation of Solution

The redemption of bonds would entail a net cash outlay of $3,472,000, but on a present-value basis it would yield $9,109,413 in net savings. The refunding NPV is thus $5,637,413:

INTERMEDIATE FINANCIAL MANAGEMENT, Chapter 18, Problem 6P , additional homework tip 3

The choice to repay instead of wait until later is much harder than finding the refunding NPV now. If interest rates were expected to fall, and therefore GST could issue debt below today's 8 percent rate in the future, then it might pay to wait. Interest rate motions, however, are very difficult to predict, if not impossible, and thus most financial managers would likely take the "bird-in - the-hand" and reimburse with such a large NPV now. Remember, however, that if the NPV were quite low, say $1,000, management would certainly have been waiting, hoping interest rates would fall lower, and waiting costs ($1,000) wouldn't have been large enough to think about.

Answer 6

Chapter 18, Problem 6P

a)

Summary Introduction

To determine: The total dollar call premium required to call the old issue, whether it is tax deductible and the net after-tax cost of the call.

a)

Expert Solution

Explanation of Solution

The overall premium is 0.11($40,000,000)=$4,400,000, since the call premium is 11 per cent. This is a tax deductible expense, though, so the actual after-tax expense is $4,400,000(1−T)=$4,400,000(1−0.4)=$2,640,000.

Answer 7

Chapter 18, Problem 6P

a)

Summary Introduction

To determine: The total dollar call premium required to call the old issue, whether it is tax deductible and the net after-tax cost of the call.

Answer 8

a)

Expert Solution

Explanation of Solution

The overall premium is 0.11($40,000,000)=$4,400,000, since the call premium is 11 per cent. This is a tax deductible expense, though, so the actual after-tax expense is $4,400,000(1−T)=$4,400,000(1−0.4)=$2,640,000.

Answer 9

a)

Expert Solution

Answer 10

a)

Expert Solution

Answer 11

Expert Solution

Answer 12

b)

Summary Introduction

To determine: The dollar floatation cost and whether it is immediately tax deductible and post-tax flotation cost.

b)

Expert Solution

Explanation of Solution

On the new issue the currency flotation rate is 0.04($40,000,000)=$1,600,000. The expense is not tax-deductible immediately and therefore the after-tax payment is $1,600,000, too. (Note that the flotation costs may be prorated and charged over the lifetime of the issue. The value of this tax savings shall be computed in Part e.).

Answer 13

b)

Summary Introduction

To determine: The dollar floatation cost and whether it is immediately tax deductible and post-tax flotation cost.

Answer 14

b)

Expert Solution

Explanation of Solution

On the new issue the currency flotation rate is 0.04($40,000,000)=$1,600,000. The expense is not tax-deductible immediately and therefore the after-tax payment is $1,600,000, too. (Note that the flotation costs may be prorated and charged over the lifetime of the issue. The value of this tax savings shall be computed in Part e.).

Answer 15

b)

Expert Solution

Answer 16

b)

Expert Solution

Answer 17

Expert Solution

Answer 18

c)

Summary Introduction

To determine: The amounts of old issue floatation cost and not been expensed and whether these deferred costs be expensed immediately if the old issue is refunded and the value of tax savings.

c)

Expert Solution

Explanation of Solution

On the old issue the flotation costs were 0.06($40,000,000)=$2,400,000. These costs have been postponed and are expensed over the issue's 25-year life, and thus $2,400,00025=$96,000 is spent annually, or $48,000 every 6 months. If the question is reimbursed, the unexpended part of the cost of the flotation can be expended immediately, resulting in tax savings of T($1,920,000)=0.40($1,920,000)=$768,000.

Answer 19

c)

Summary Introduction

To determine: The amounts of old issue floatation cost and not been expensed and whether these deferred costs be expensed immediately if the old issue is refunded and the value of tax savings.

Answer 20

c)

Expert Solution

Explanation of Solution

On the old issue the flotation costs were 0.06($40,000,000)=$2,400,000. These costs have been postponed and are expensed over the issue's 25-year life, and thus $2,400,00025=$96,000 is spent annually, or $48,000 every 6 months. If the question is reimbursed, the unexpended part of the cost of the flotation can be expended immediately, resulting in tax savings of T($1,920,000)=0.40($1,920,000)=$768,000.

Answer 21

c)

Expert Solution

Answer 22

c)

Expert Solution

Answer 23

Expert Solution

Answer 24

d)

Summary Introduction

To determine: The net post-tax cash outlay needed to refund the old issue.

d)

Expert Solution

Explanation of Solution

INTERMEDIATE FINANCIAL MANAGEMENT, Chapter 18, Problem 6P , additional homework tip 1

Answer 25

d)

Summary Introduction

To determine: The net post-tax cash outlay needed to refund the old issue.

Answer 26

d)

Expert Solution

Explanation of Solution

INTERMEDIATE FINANCIAL MANAGEMENT, Chapter 18, Problem 6P , additional homework tip 1

Answer 27

d)

Expert Solution

Answer 28

d)

Expert Solution

Answer 29

Expert Solution

Answer 30

e)

Summary Introduction

To determine: The semiannual tax savings that arises from amortizing the floatation cost and the foregone semiannual tax savings on the old-issue floatation cost.

e)

Expert Solution

Explanation of Solution

The $1,600,000 cost of new issue flotation would be depreciated over the issue's 20-year existence. Therefore, it would cost $1,600,00020=$80,000 every year, or $40,000 every six months. The tax savings from this tax deduction are (0.40×$40,000)=$16,000 per half-year. By reimbursing the old issue and spending the surviving old issue flotation costs instantly, the company forgoes the opportunity to continue spending on the old flotation costs over time. In total, $2,400,00025=$96,000 annually, or $48,000 semi-annually. The forgone value for every $48,000 deduction is 0.40($48,000)=$19,200.

Answer 31

e)

Summary Introduction

To determine: The semiannual tax savings that arises from amortizing the floatation cost and the foregone semiannual tax savings on the old-issue floatation cost.

Answer 32

e)

Expert Solution

Explanation of Solution

The $1,600,000 cost of new issue flotation would be depreciated over the issue's 20-year existence. Therefore, it would cost $1,600,00020=$80,000 every year, or $40,000 every six months. The tax savings from this tax deduction are (0.40×$40,000)=$16,000 per half-year. By reimbursing the old issue and spending the surviving old issue flotation costs instantly, the company forgoes the opportunity to continue spending on the old flotation costs over time. In total, $2,400,00025=$96,000 annually, or $48,000 semi-annually. The forgone value for every $48,000 deduction is 0.40($48,000)=$19,200.

Answer 33

e)

Expert Solution

Answer 34

e)

Expert Solution

Answer 35

Expert Solution

Answer 36

f)

Summary Introduction

To determine: The semiannually post-tax interest savings that would result from the refunding.

f)

Expert Solution

Explanation of Solution

The interest on the old issue is 0.11($40,000,000)=$4,400,000 per annum, or $2,200,000 per term. Since interest payments are tax deductible the semi-annual after-tax balance is 0.6($2,200,000)=$1,320,000. The new issue bears a coupon rate of 8 percent. The annual interest would therefore be 0.08($40,000,000)=$3,200,000, or $1,600,000 semi-annually. Therefore the after-tax cost is 0.6($1,600,000)=$960,000. Thus, after-tax net interest savings would be $1,320,000 or $960,000 = $360,000 semi-annually if reimbursement takes place.

Answer 37

f)

Summary Introduction

To determine: The semiannually post-tax interest savings that would result from the refunding.

Answer 38

f)

Expert Solution

Explanation of Solution

The interest on the old issue is 0.11($40,000,000)=$4,400,000 per annum, or $2,200,000 per term. Since interest payments are tax deductible the semi-annual after-tax balance is 0.6($2,200,000)=$1,320,000. The new issue bears a coupon rate of 8 percent. The annual interest would therefore be 0.08($40,000,000)=$3,200,000, or $1,600,000 semi-annually. Therefore the after-tax cost is 0.6($1,600,000)=$960,000. Thus, after-tax net interest savings would be $1,320,000 or $960,000 = $360,000 semi-annually if reimbursement takes place.

Answer 39

f)

Expert Solution

Answer 40

f)

Expert Solution

Answer 41

Expert Solution

Answer 42

g)

Summary Introduction

To determine: The sum of these two semiannual cash flows and appropriate discount rate to apply to these two semiannual cash flows and the present value.

g)

Expert Solution

Explanation of Solution

The estimated amortization tax benefits over 20 years are about $3,200 per year, while the net interest costs over 20 years are about $360,000 per year. The net semi-annual cash balance, as shown below, is thus $356,800.

INTERMEDIATE FINANCIAL MANAGEMENT, Chapter 18, Problem 6P , additional homework tip 2

The cash flows are predicated on treaty obligations and therefore have about the same level of risk as to the debt of the company. In fact, the cash flows are already tax-net. Consequently, the suitable interest rate is the after-tax cost of debt to GST.(The citation of the cash to fund the net investment expenditure also affects the discount rate, but most companies use debt to finance that expenditure, and in this case, the discount rate should be the after-tax debt cost.)Finally, as we are valuing future flows, the correct debt cost is the cost of today, or the cost of the new issue, and not the debt cost that floated five years ago. The appropriate rate of discount is thus 0.6(8 percent) = 4.8 percent per annum, or 2.4 percent per semi-annual period.

Answer 43

g)

Summary Introduction

To determine: The sum of these two semiannual cash flows and appropriate discount rate to apply to these two semiannual cash flows and the present value.

Answer 44

g)

Expert Solution

Explanation of Solution

The estimated amortization tax benefits over 20 years are about $3,200 per year, while the net interest costs over 20 years are about $360,000 per year. The net semi-annual cash balance, as shown below, is thus $356,800.

INTERMEDIATE FINANCIAL MANAGEMENT, Chapter 18, Problem 6P , additional homework tip 2

The cash flows are predicated on treaty obligations and therefore have about the same level of risk as to the debt of the company. In fact, the cash flows are already tax-net. Consequently, the suitable interest rate is the after-tax cost of debt to GST.(The citation of the cash to fund the net investment expenditure also affects the discount rate, but most companies use debt to finance that expenditure, and in this case, the discount rate should be the after-tax debt cost.)Finally, as we are valuing future flows, the correct debt cost is the cost of today, or the cost of the new issue, and not the debt cost that floated five years ago. The appropriate rate of discount is thus 0.6(8 percent) = 4.8 percent per annum, or 2.4 percent per semi-annual period.

Answer 45

g)

Expert Solution

Answer 46

g)

Expert Solution

Answer 47

Expert Solution

Answer 48

h)

Summary Introduction

To determine: The NPV of refunding and whether the GST refund now or wait until later.

h)

Expert Solution

Explanation of Solution

The redemption of bonds would entail a net cash outlay of $3,472,000, but on a present-value basis it would yield $9,109,413 in net savings. The refunding NPV is thus $5,637,413:

INTERMEDIATE FINANCIAL MANAGEMENT, Chapter 18, Problem 6P , additional homework tip 3

The choice to repay instead of wait until later is much harder than finding the refunding NPV now. If interest rates were expected to fall, and therefore GST could issue debt below today's 8 percent rate in the future, then it might pay to wait. Interest rate motions, however, are very difficult to predict, if not impossible, and thus most financial managers would likely take the "bird-in - the-hand" and reimburse with such a large NPV now. Remember, however, that if the NPV were quite low, say $1,000, management would certainly have been waiting, hoping interest rates would fall lower, and waiting costs ($1,000) wouldn't have been large enough to think about.

Answer 49

h)

Summary Introduction

To determine: The NPV of refunding and whether the GST refund now or wait until later.

Answer 50

h)

Expert Solution

Explanation of Solution

The redemption of bonds would entail a net cash outlay of $3,472,000, but on a present-value basis it would yield $9,109,413 in net savings. The refunding NPV is thus $5,637,413:

INTERMEDIATE FINANCIAL MANAGEMENT, Chapter 18, Problem 6P , additional homework tip 3

The choice to repay instead of wait until later is much harder than finding the refunding NPV now. If interest rates were expected to fall, and therefore GST could issue debt below today's 8 percent rate in the future, then it might pay to wait. Interest rate motions, however, are very difficult to predict, if not impossible, and thus most financial managers would likely take the "bird-in - the-hand" and reimburse with such a large NPV now. Remember, however, that if the NPV were quite low, say $1,000, management would certainly have been waiting, hoping interest rates would fall lower, and waiting costs ($1,000) wouldn't have been large enough to think about.

Answer 51

h)

Expert Solution

Answer 52

h)

Expert Solution

Answer 53

Expert Solution

Answer 54

Ch. 18 - Prob. 1Q Ch. 18 - Prob. 2Q Ch. 18 - Prob. 3Q Ch. 18 - Prob. 4Q Ch. 18 - Prob. 5Q Ch. 18 - Profit or Loss on New Stock Issue Security Brokers...Ch. 18 - Prob. 2P Ch. 18 - Benjamin Garcia’s start-up business is succeeding,...Ch. 18 - Prob. 5P Ch. 18 - Prob. 6P

The total dollar call premium required to call the old issue, whether it is tax deductible and the net after-tax cost of the call.

To determine: The total dollar call premium required to call the old issue, whether it is tax deductible and the net after-tax cost of the call.

Explanation of Solution

To determine: The dollar floatation cost and whether it is immediately tax deductible and post-tax flotation cost.

Explanation of Solution

To determine: The amounts of old issue floatation cost and not been expensed and whether these deferred costs be expensed immediately if the old issue is refunded and the value of tax savings.

Explanation of Solution

To determine: The net post-tax cash outlay needed to refund the old issue.

Explanation of Solution

To determine: The semiannual tax savings that arises from amortizing the floatation cost and the foregone semiannual tax savings on the old-issue floatation cost.

Explanation of Solution

To determine: The semiannually post-tax interest savings that would result from the refunding.

Explanation of Solution

To determine: The sum of these two semiannual cash flows and appropriate discount rate to apply to these two semiannual cash flows and the present value.

Explanation of Solution

To determine: The NPV of refunding and whether the GST refund now or wait until later.

Explanation of Solution

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