10. Refunding analysis Consider yourself the CFO of ToughNut Corp. Management is considering whether the company should refund its $960,000, 20.00% coupon, 10-year bond issue that was sold at par 3 years ago. The flotation cost on this issue was $4,800 that has been amortizing on a straight-line basis over the 10- year original life of the issue. ToughNut Corp. has a tax rate of 35%, and current short term rates are 6%. You have collected the following data about the existing bond and the potential new bond issue: Data Collected Existing Bond New Bond $960,000 $960,000 $4,800 $4,240 10 8 Capital Flotation cost Maturity Years since issue Coupon Call premium After-tax cost of new debt 3 0 12.00% 20.00% 16.00% 7.80% Step 1: Determining the initial investment outlay Schedule of Cash Flows Before Tax After Tax Check if Correct Investment Outlay Call premium on the old bond Flotation cost on new issue Immediate tax savings on old flotation cost expense Total after-tax investment -$153,600 -$4,240 $3,360 -$99,840 - $4,240 $1,176 -$102,904 Based on the information given to you, solve for step 2 (annual flotation cost tax effects) and step 3 (annual interest savings) by completing the following steps in the refunding analysis. Step 2: Calculating the annual flotation cost tax effects Step 2: Calculating the annual flotation cost tax effects 1. For tax purposes, the flotation cost must be amortized over the life of the new bond, which is 8 years. Thus, the after-tax saving every year for the next 8 years will be 2. Toughnut Corp., however, will no longer receive a tax deduction on the flotation cost on the old issue and will thus lose an after-tax benefit of 3. The net amortization tax effect on the flotation cost is the difference between the old and the new issue, which is years. If the company issues new bonds, the tax savings from amortizing the flotation costs will per year for the next Step 3: Calculating the annual interest savings 1. The annual coupon payments on the old bonds were $192,000.00. Thus, the after-tax interest on the old issue is 2. The after-tax interest on the new bonds is 3. Thus, the net annual interest savings after tax will be At the final stage of the refunding analysis, you need to calculate the net present values (NPV) of the savings and costs and the NPV of the entire refunding operation. (Round your answer to two decimal places.) Step 4: Calculating the NPV of the refunding Value Present value of amortized tax effects Present value of interest savings Net investment outlay NPV from refunding -$102,904 Choices for Step 1: Correct or not correct Choices for Step 2 question 1: a) 166.95 b) 168 C) 259.70 d) 185.50 Choices for Step 2 question 2: a) 100.80 b) 168 c) 218.40 d) 134.40 Choices for Step 2 question 3: a) 14 b) 22.75 C) 17.50 d) 10.50 # of years choices: a) 13 b) 8 c) 10 d) 3 Floatation costs will: Increase or Decrease Choices for Step 3 question 1: a) 162,240 b) 99,840 C) 124,800 d) 74,880 Choices for Step 3 question 2: a) 104,832 b) 89,856 C) 67,392 d) 74,880 Choices for Step 3 question 3: a) 49,920 b) 59,904 C) 54,912 d) 64,896 Choices for Step 4 question 1: a) 212.79 b) 202.66 C) 101.33 d) 121.60 Choices for Step 4 question 2: a) 462,499.86 b) 346,874.89 c) 289,062.41 d) 520,312.34 Choices for Step 4 question 3: a) 223,511.69 b) -102,802.67 C) 186,259.74 d) 290,163.74 10. Refunding analysis Consider yourself the CFO of ToughNut Corp. Management is considering whether the company should refund its $960,000, 20.00% coupon, 10-year bond issue that was sold at par 3 years ago. The flotation cost on this issue was $4,800 that has been amortizing on a straight-line basis over the 10- year original life of the issue. ToughNut Corp. has a tax rate of 35%, and current short term rates are 6%. You have collected the following data about the existing bond and the potential new bond issue: Data Collected Existing Bond New Bond $960,000 $960,000 $4,800 $4,240 10 8 Capital Flotation cost Maturity Years since issue Coupon Call premium After-tax cost of new debt 3 0 12.00% 20.00% 16.00% 7.80% Step 1: Determining the initial investment outlay Schedule of Cash Flows Before Tax After Tax Check if Correct Investment Outlay Call premium on the old bond Flotation cost on new issue Immediate tax savings on old flotation cost expense Total after-tax investment -$153,600 -$4,240 $3,360 -$99,840 - $4,240 $1,176 -$102,904 Based on the information given to you, solve for step 2 (annual flotation cost tax effects) and step 3 (annual interest savings) by completing the following steps in the refunding analysis. Step 2: Calculating the annual flotation cost tax effects Step 2: Calculating the annual flotation cost tax effects 1. For tax purposes, the flotation cost must be amortized over the life of the new bond, which is 8 years. Thus, the after-tax saving every year for the next 8 years will be 2. Toughnut Corp., however, will no longer receive a tax deduction on the flotation cost on the old issue and will thus lose an after-tax benefit of 3. The net amortization tax effect on the flotation cost is the difference between the old and the new issue, which is years. If the company issues new bonds, the tax savings from amortizing the flotation costs will per year for the next Step 3: Calculating the annual interest savings 1. The annual coupon payments on the old bonds were $192,000.00. Thus, the after-tax interest on the old issue is 2. The after-tax interest on the new bonds is 3. Thus, the net annual interest savings after tax will be At the final stage of the refunding analysis, you need to calculate the net present values (NPV) of the savings and costs and the NPV of the entire refunding operation. (Round your answer to two decimal places.) Step 4: Calculating the NPV of the refunding Value Present value of amortized tax effects Present value of interest savings Net investment outlay NPV from refunding -$102,904 Choices for Step 1: Correct or not correct Choices for Step 2 question 1: a) 166.95 b) 168 C) 259.70 d) 185.50 Choices for Step 2 question 2: a) 100.80 b) 168 c) 218.40 d) 134.40 Choices for Step 2 question 3: a) 14 b) 22.75 C) 17.50 d) 10.50 # of years choices: a) 13 b) 8 c) 10 d) 3 Floatation costs will: Increase or Decrease Choices for Step 3 question 1: a) 162,240 b) 99,840 C) 124,800 d) 74,880 Choices for Step 3 question 2: a) 104,832 b) 89,856 C) 67,392 d) 74,880 Choices for Step 3 question 3: a) 49,920 b) 59,904 C) 54,912 d) 64,896 Choices for Step 4 question 1: a) 212.79 b) 202.66 C) 101.33 d) 121.60 Choices for Step 4 question 2: a) 462,499.86 b) 346,874.89 c) 289,062.41 d) 520,312.34 Choices for Step 4 question 3: a) 223,511.69 b) -102,802.67 C) 186,259.74 d) 290,163.74