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Chapter Ch 20-06 Build a Model
Note: Fill in the shaded cells with the appropriate formula
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 old the 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
Coupon rate
Original maturity
Remaining maturity
Original flotation costs
Call premium
Tax rate
Refunding data
Coupon rate
Maturity
Flotation costs
Time between issuing new bonds and calling old bonds (months)
Rate earned on proceeds of new bonds before calling old bonds (annual)
a. Perform a complete bond refunding analysis. What is the bond refunding's NPV?
$70,000,000
10%
30
22
$4,500,000
10%
40%
8.0000%
22
$5,000,000
1
5%
I
4/19/2010