FIN - Schumann Shoe Manufacturer
Question # 00030847
Posted By:
Updated on: 11/06/2014 12:00 PM Due on: 11/06/2014
Schumann Shoe Manufacturer is considering whether or not to refund a $70 million, 10% coupon, 30-year bond issue that was sold 8 years ago. It is amortizing $4.5 million of flotation costs on the 10% bonds over the issue's 30-year life. Schumann's investment bankers have indicated that the company could sell a new 22-year issue at an interest rate of 8 percent in today's market. Neither they nor Schumann's management anticipate that interest rates will fall below 6 percent any time soon, but there is a chance that interest rates will increase.
A call premium of 10 percent would be required to retire the old bonds, and flotation costs on the new issue would amount to $5 million. Schumann's marginal federal-plus-state tax rate is 40 percent. The new bonds would be issued 1 month before the old bonds are called, with the proceeds being invested in short-term government securities returning 5 percent annually during the interim period.
Current bond issue data
Par value $70,000,000
Coupon rate 10%
Original maturity 30
Remaining maturity 22
Original flotation costs $4,500,000
Call premium 10%
Tax rate 40%
Refunding data
Coupon rate 8.0000%
Maturity 22
Flotation costs $5,000,000
Time between issuing new bonds and calling old bonds (months) 1
Rate earned on proceeds of new bonds before calling old bonds (annual) 5%
a. Perform a complete bond refunding analysis. What is the bond refunding's NPV?
Initial investment outlay to refund old issue:
Call premium on old issue =
After-tax call premium =
New flotation cost =
Old flotation costs already expensed =
Remaining flotation costs to expense =
Tax savings from old flotation costs = You get to expense the remaining flotation costs
Additional interest on old issue after tax = This is interest paid on the old bond issue between when the new bonds are issued and the old bonds are retired
Interest earned on investment in T-bonds after tax = This is interest earned on the proceeds from the new bonds before they are used to pay off the old bonds.
Total investment outlay =
Annual Flotation Cost Tax Effects:
Annual tax savings on new flotation =
Tax savings lost on old flotation =
Total amortization tax effects =
Annual interest savings due to refunding:
Annual after tax interest on old bond =
Annual after tax interest on new bond =
Net after tax interest savings =
Annual cash flows =
After-tax cost of new debt =
NPV of refunding decision =
b. At what interest rate on the new debt is the NPV of the refunding no longer positive?
Use Goal Seek to set cell D60 to zero by changing cell C27.
"Break-even" interest rate =
A call premium of 10 percent would be required to retire the old bonds, and flotation costs on the new issue would amount to $5 million. Schumann's marginal federal-plus-state tax rate is 40 percent. The new bonds would be issued 1 month before the old bonds are called, with the proceeds being invested in short-term government securities returning 5 percent annually during the interim period.
Current bond issue data
Par value $70,000,000
Coupon rate 10%
Original maturity 30
Remaining maturity 22
Original flotation costs $4,500,000
Call premium 10%
Tax rate 40%
Refunding data
Coupon rate 8.0000%
Maturity 22
Flotation costs $5,000,000
Time between issuing new bonds and calling old bonds (months) 1
Rate earned on proceeds of new bonds before calling old bonds (annual) 5%
a. Perform a complete bond refunding analysis. What is the bond refunding's NPV?
Initial investment outlay to refund old issue:
Call premium on old issue =
After-tax call premium =
New flotation cost =
Old flotation costs already expensed =
Remaining flotation costs to expense =
Tax savings from old flotation costs = You get to expense the remaining flotation costs
Additional interest on old issue after tax = This is interest paid on the old bond issue between when the new bonds are issued and the old bonds are retired
Interest earned on investment in T-bonds after tax = This is interest earned on the proceeds from the new bonds before they are used to pay off the old bonds.
Total investment outlay =
Annual Flotation Cost Tax Effects:
Annual tax savings on new flotation =
Tax savings lost on old flotation =
Total amortization tax effects =
Annual interest savings due to refunding:
Annual after tax interest on old bond =
Annual after tax interest on new bond =
Net after tax interest savings =
Annual cash flows =
After-tax cost of new debt =
NPV of refunding decision =
b. At what interest rate on the new debt is the NPV of the refunding no longer positive?
Use Goal Seek to set cell D60 to zero by changing cell C27.
"Break-even" interest rate =
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Rating:
/5
Solution: FIN - Schumann Shoe Manufacturer Solution