The Harding Corporation has $52 million of bonds outstanding that were issued at a coupon rate of 13.25 percent seven years ago. Interest rates have fallen to 11.6 percent. Preston Alter, the vice-president of finance, does not expect rates to fall any further. The bonds have 18 years left to maturity, and Preston would like to refund the bonds with a new issue of equal amount also having 18 years to maturity. The Harding Corporation has a tax rate of 22 percent. The underwriting cost on the old issue was 4.5 percent of the total bond value. The underwriting cost on the new issue will be 1.8 percent of the total bond value. The original bond indenture contained a five-year protection against a call, with an 8 percent call premium starting in the sixth year and scheduled to decline by one-half percent each year thereafter (Consider the bond to be seven years old for purposes of computing the premium). Use Appendix D. a. Compute the discount rate. (Round the final answer to 2 decimal places.) Discount rate 9.00 ± 2% % b. Calculate the present value of total outflows. (Enter the answers in whole dollars, not in millions. Round "PV Factor" to 3 decimal places. Do not round intermediate calculations. Round the final answer to nearest whole dollar.) Total outflows $ 4,672,168 ± 2% c. Calculate the present value of total inflows. (Enter the answers in whole dollars, not in millions. Round "PV Factor" to 3 decimal places. Do not round intermediate calculations. Round the final answer to nearest whole dollar.) Total inflows $ 5,776,524 ± 2% d. Calculate the net present value. (Enter the answers in whole dollars, not in millions. Round "PV Factor" to 3 decimal places. Do not round intermediate calculations. Round the final answer to nearest whole dollar. Negative amount should be indicated by a minus sign.) Net present value $ 1,104,356 ± 2% e. Should the Harding Corporation refund the old issue? multiple choice 2 No YesCorrectCorrect Explanation a. Discount rate r (%I/Y) = 11.6% (1 – 0.23) = 9% b. Costs (Outflows) 1. Payment of call premium: $52,000,000 × 7.5% = $3,900,000 2. Borrowing expenses of new issue: Underwriting cost = 1.8 % × $52 million = $936,000 Amortization of expenses ($936,000 / 5) (0.23) = $187,200 (0.23) $42,120 tax savings per year Actual expenditure = $936,000 PV of future tax savings $42,120 @ PVIFA (N = 5, %I/Y = 9%) = (163,832) Net cost of borrowing expenses of new issue $772,168 3. No overlap period: c . Benefits (Inflows) 4. Cost savings in lower interest rates: 13.25% (Interest on old bond) × $52,000,000 = $6,890,000 12% (Interest on new bond) × $52,000,000 = (6,038,710) Savings per year = $851,290 Aftertax savings per year $851,290.32 × (1 – 0.23) = $ 659,750 PV of annual aftertax interest savings $659,750/year @ PVIFA (N= 18, %I/Y = 9%) = $5,776,524 d. Summary Costs Benefits 1. $3,900,000 2. 772,168 3. 0 4. $5,776,524 PV of outflows ($4,672,168) PV of inflows $5,776,524 NPV (Net present value) = $1,104,356 e. The Harding Corporation should refund the issue, as the NPV is positive at this time. Can you please explain where they got the 0.23

The Harding Corporation has $52 million of bonds outstanding that were issued at a coupon rate of 13.25 percent seven years ago. Interest rates have fallen to 11.6 percent. Preston Alter, the vice-president of finance, does not expect rates to fall any further. The bonds have 18 years left to maturity, and Preston would like to refund the bonds with a new issue of equal amount also having 18 years to maturity. The Harding Corporation has a tax rate of 22 percent. The underwriting cost on the old issue was 4.5 percent of the total bond value. The underwriting cost on the new issue will be 1.8 percent of the total bond value. The original bond indenture contained a five-year protection against a call, with an 8 percent call premium starting in the sixth year and scheduled to decline by one-half percent each year thereafter (Consider the bond to be seven years old for purposes of computing the premium). Use Appendix D. a. Compute the discount rate. (Round the final answer to 2 decimal places.) Discount rate 9.00 ± 2% % b. Calculate the present value of total outflows. (Enter the answers in whole dollars, not in millions. Round "PV Factor" to 3 decimal places. Do not round intermediate calculations. Round the final answer to nearest whole dollar.) Total outflows $ 4,672,168 ± 2% c. Calculate the present value of total inflows. (Enter the answers in whole dollars, not in millions. Round "PV Factor" to 3 decimal places. Do not round intermediate calculations. Round the final answer to nearest whole dollar.) Total inflows $ 5,776,524 ± 2% d. Calculate the net present value. (Enter the answers in whole dollars, not in millions. Round "PV Factor" to 3 decimal places. Do not round intermediate calculations. Round the final answer to nearest whole dollar. Negative amount should be indicated by a minus sign.) Net present value $ 1,104,356 ± 2% e. Should the Harding Corporation refund the old issue? multiple choice 2 No YesCorrectCorrect Explanation a. Discount rate r (%I/Y) = 11.6% (1 – 0.23) = 9% b. Costs (Outflows) 1. Payment of call premium: $52,000,000 × 7.5% = $3,900,000 2. Borrowing expenses of new issue: Underwriting cost = 1.8 % × $52 million = $936,000 Amortization of expenses ($936,000 / 5) (0.23) = $187,200 (0.23) $42,120 tax savings per year Actual expenditure = $936,000 PV of future tax savings $42,120 @ PVIFA (N = 5, %I/Y = 9%) = (163,832) Net cost of borrowing expenses of new issue $772,168 3. No overlap period: c . Benefits (Inflows) 4. Cost savings in lower interest rates: 13.25% (Interest on old bond) × $52,000,000 = $6,890,000 12% (Interest on new bond) × $52,000,000 = (6,038,710) Savings per year = $851,290 Aftertax savings per year $851,290.32 × (1 – 0.23) = $ 659,750 PV of annual aftertax interest savings $659,750/year @ PVIFA (N= 18, %I/Y = 9%) = $5,776,524 d. Summary Costs Benefits 1. $3,900,000 2. 772,168 3. 0 4. $5,776,524 PV of outflows ($4,672,168) PV of inflows $5,776,524 NPV (Net present value) = $1,104,356 e. The Harding Corporation should refund the issue, as the NPV is positive at this time. Can you please explain where they got the 0.23

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter6: Fixed-income Securities: Characteristics And Valuation

Section: Chapter Questions

Problem 17P

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Explanation

Discount rate r (%I/Y) = 11.6% (1 – 0.23) = 9%

Costs (Outflows)

1. Payment of call premium:

$52,000,000 × 7.5% = $3,900,000

2. Borrowing expenses of new issue:

Underwriting cost = 1.8 % × $52 million = $936,000

Amortization of expenses ($936,000 / 5) (0.23)

= $187,200 (0.23)

$42,120 tax savings per year


Actual expenditure	=	$936,000
PV of future tax savings $42,120 @ PV_IFA (N = 5, %I/Y = 9%)	=	(163,832)

Net cost of borrowing expenses of new issue		$772,168

3. No overlap period:

c .

Benefits (Inflows)

4. Cost savings in lower interest rates:


13.25% (Interest on old bond) × $52,000,000	=	$6,890,000
12% (Interest on new bond) × $52,000,000	=	(6,038,710)

Savings per year	=	$851,290

Aftertax savings per year $851,290.32 × (1 – 0.23) = $ 659,750

PV of annual aftertax interest savings $659,750/year @ PV_IFA (N= 18, %I/Y = 9%) = $5,776,524


	Summary	Costs		Benefits
1.		$3,900,000
2.		772,168
3.		0	4.	$5,776,524

	PV of outflows	($4,672,168)	PV of inflows	$5,776,524

NPV (Net present value) = $1,104,356

The Harding Corporation should refund the issue, as the NPV is positive at this time.

Can you please explain where they got the 0.23

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