FM11_Ch_19_Tool_Kit

FM11_Ch_19_Tool_Kit - A 4 5 6 7 8 9 10 11 12 13 14 15 16 17...

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REFUNDING OPERATIONS Input Data (in thousands of dollars) Existing bond issue $60,000 New bond issue $60,000 Original flotation cost $3,000 New flotation cost $2,650 Maturity of original debt 25 New bond maturity 20 Years since old debt issue 5 New cost of debt 9% Call premium (%) 10% Original coupon rate 12% Tax rate 40% After-tax cost of new debt 5.4% Short-term interest rate 6% Schedule of cash flows Before-tax After-tax Investment Outlay Call premium on the old bond ($6,000) ($3,600) Flotation costs on new issue (2,650) (2,650) Immediate tax savings on old flotation cost expense 2,400 960 Extra interest paid on old issue (600) (360) Interest earned on short-term investment 300 180 Total after-tax investment ($5,470) Annual Flotation Cost Tax Effects: t=1 to 20 Annual tax savings from new issue flotation costs $133 $53 Annual lost tax savings from old issue flotation costs (120) (48) Net flotation cost tax savings $13 $5 Annual Interest Savings Due to Refunding: t=1 to 20 Interest on old bond $7,200 $4,320 Interest on new bond (5,400) (3,240) Net interest savings $1,800 $1,080 Calculating the annual flotation cost tax effects and the annual interest savings Annual flotation Cost Tax Effects Annual 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% Annual flotation cost tax savings (Pmt) $5 Annual interest savings (Pmt) $1,080 NPV of annual flotation cost savings $60 NPV of annual interest savings $13,014 Bond Refunding NPV =Initial Outlay + PV of flotation costs + PV of interest savings Bond Refunding NPV = ($5,470) + $60 + $13,014 Bond Refund NPV = $7,604.425 This example examines the issue of replacing existing debt with newly issued debt. First, "Is it profitable to call an outstanding issue and replace it with a new issue?". Second, 'even if refunding now is profitable, "Would the firm's expected value be further increased if the refunding were 'postponed until a later date?" The firm should refund only if the present value of the savings exceeds the cost of the refunding. The after-tax cost of debt
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FM11_Ch_19_Tool_Kit - A 4 5 6 7 8 9 10 11 12 13 14 15 16 17...

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