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# CH12 - Flotation costs are 2 percent and there are no taxes...

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CHAPTER 12 8. A firm has a perpetual callable bond outstanding with a par value of \$100 and an annual coupon of \$14. The firm can refund this with a new noncallable perpetual bond having an 8 percent coupon. The call price on the old bond is \$114. Flotation costs for a new issue are 2 percent of par. What is the myopic benefit of refunding? Benefit = (14 – 8)/0.08 – 14 – 2 = 75 – 16 = 59 9. In Problem 8, how would your answer change if the new bond was callable and had a coupon of 10 percent? Benefit = (14 – 10)/0.10 – 16 = 40 – 16 = 24 10. If there is a corporate income tax rate of 30 percent, how does your answer to Problem 8 change? Benefit = ) 3 . 0 1 ( 16 ) 30 . 0 1 ( 08 . 0 ) 8 14 ( - - - - = 41.3 11. A firm has a perpetual callable bond with a 12 percent coupon. The bond has a call premium of 12 percent.

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Unformatted text preview: Flotation costs are 2 percent and there are no taxes. The firm can refund immediately with a 9 percent noncallable perpetual bond. If it decides to postpone refunding until next period, interest rates on noncallable bonds will be 6 percent, 9 percent, or 12 percent, each with probability of 1/3. Should the firm refund immediately or wait? Initially, consider the case where the firm is risk neutral. Then, introduce risk aversion. Benefit Refund Now = (12 – 9)/0.09 – 12 - 2 = 19.33 Now Now + 1 Benefit at Now + 1 PV[-C + Benefit at Now + 1]-12/(1.09) = -11.009174 12% + 31.33 (-12 + 31.33)/1.09 = 17.733945 6% + 98 (-12 + 98)/1.09 = 78.899083 (12 – 6)/0.06 – 12 - 2 = 86 SUM/3 = 28.54 9% It is better to refund immediately....
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