Business Finance Answers_Part_33

Business Finance Answers_Part_33 - CHAPTER 7 B-129 c. The...

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CHAPTER 7 B-129 c . The total coupon payment for the coupon bonds will be the number bonds times the coupon payment. For the cash flow of the coupon bonds, we need to account for the tax deductibility of the interest payments. To do this, we will multiply the total coupon payment times one minus the tax rate. So: Coupon bonds: (30,000)($80)(1–.35) = $1,560,000 cash outflow Note that this is cash outflow since the company is making the interest payment. For the zero coupon bonds, the first year interest payment is the difference in the price of the zero at the end of the year and the beginning of the year. The price of the zeroes in one year will be: P 1 = $1,000/1.04 58 = $102.82 The year 1 interest deduction per bond will be this price minus the price at the beginning of the year, which we found in part b , so: Year 1 interest deduction per bond = $102.82 – 95.06 = $7.76 The total cash flow for the zeroes will be the interest deduction for the year times the number of zeroes sold, times the tax rate. The cash flow for the zeroes in year 1 will be: Cash flows for zeroes in Year 1 = (315,589)($7.76)(.35) = $856,800.00 Notice the cash flow for the zeroes is a cash inflow. This is because of the tax deductibility of the imputed interest expense. That is, the company gets to write off the interest expense for the year even though the company did not have a cash flow for the interest expense. This reduces the company’s tax liability, which is a cash inflow. During the life of the bond, the zero generates cash inflows to the firm in the form of the interest tax shield of debt. We should note an important point here: If you find the PV of the cash flows from the coupon bond and the zero coupon bond, they will be the same. This is because of the much larger repayment amount for the zeroes.
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This document was uploaded on 10/31/2011 for the course FIN 3403 at University of Florida.

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Business Finance Answers_Part_33 - CHAPTER 7 B-129 c. The...

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