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Unformatted text preview: REFUNDING OPERATIONS (Section 19.8) Input Data (in thousands of dol ars) Existing bond is ue = $60,0 0 New bond is ue = $60,0 0 Original flotation cost = $3,0 0 New flotation cost = $2,650 Maturity of original debt = 25 New bond maturity = 20 Years since old debt is ue = 5 New cost of debt = 9.0% Cal premium (%) = 10.0% Original coupon rate = 12.0% Tax rate = 40.0% After-tax cost of new debt = 5.4% Short-term interest rate = 6.0% Schedule of cash flows Before-tax After-tax Investment Outlay Cal premium on the old bond ($6,0 0.0) ($3,60 .0) Flotation costs on new is ue ($2,650.0) ($2,650.0) Im ediate tax savings on old flotation cost expense $2,40 .0 $960.0 Extra interest paid on old is ue ($60 .0) ($360.0) Interest earned on short-term investment $30 .0 $180.0 Total after-tax investment ($5,470.0) An ual Flotation Cost Tax Ef ects: t=1 to 20 An ual tax savings from new is ue flotation costs $132.5 $53.0 An ual lost tax savings from old is ue flotation costs ($120.0) ($48.0) Net flotation cost tax savings $12.5 $5.0 An ual Interest Savings Due to Refunding: t=1 to 20 Interest on old bond $7,20 .0 $4,320.0 Interest on new bond ($5,40 .0) ($3,240.0) Net interest savings $1,80 .0 $1,080.0 Calculating the an ual flotation cost tax ef ects and the an ual interest savings An ual flotation Cost Tax Ef ects An ual Interest Savings Maturity of the new bond (Nper) 20 Maturity of the new bond (Nper) 20 After-tax cost of new debt (Rate) 5.4% After-tax cost of new debt (Rate) 5.4% An ual flotation cost tax savings (Pmt) $5 An ual interest savings (Pmt) $1,080 NPV of an ual flotation cost savings $60.251 NPV of an ual interest savings $13,014.174 Bond Refunding NPV = Initial Outlay + PV of flotation costs + PV of interest savings Bond Refunding NPV = ($5,470.0 0) + $60.251 + $13,014.174 Bond Refund NPV = $7,604.425 This example examines the is ue of replacing existing debt with newly is ued debt. First, is it profitable to cal an outstanding is ue and replace it with a new is ue? replace it with a new is ue?...
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