Refunding Analysis

Step 1: check if correct

Step 2:

1. $138.34, $103.75, $115.28, or $161.39

2. $83.52, $135.72, $62.64, $104.40

3. The net amortization tax effect on the flotation cost is the difference between the old and the new issue which is (part a) $8.70, $6.53, $10.88, or $14.14 per year for the next (part b) 13, 8, 10, or 3 years. If the company issues new bonds, the tax savings from amortizing the flotation costs will (part c) increase or decrease.

Step 3:

1. $70,644.00, $56,515.20, $42,386.40, or $91,837.20

2. $42,386.40, $59,340.96, $38,147.76, or $50,863.68

3. $33,909.12, $28,257.60, $36,734.88, or $31,083.36

Step 4:

Present Value of amortized tax effects: $67.32, $134.64, $80.78, or $141.37

Present Value of interest savings: $279,760.86, $314,730.97, $209,820.65, or $174,850.54

NPV from refunding: $139,271.83, -$58,790.68, $116,059.86, or $175,917.86

. neiuuung auaryDI n.18 Kefunding, Analysis $696,000, 14.50% Coupon, 10-year bond issue that was sold at par 3 years ago. The flotation cost on this issue was Consider yourself the CFO of ToughNut Corp. Management is considering whether the company should refund its $3,480 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 30 % , 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 New Bond Existing Bond $696,000 $696,000 Capital $3,074 $3,480 Flotation cost 8 10 Maturity 0 3 Years since issue 8.70% 14.50% Coupon 11.60% Call premium 6.09% After-tax cost of new debt The associate financial analyst on the finance team has done some preliminary refunding analysis and submitted the following calculations to you. Consider this as step 1 in the refunding analysis. Assume that the company pays no additional interest on the old issue and earns no interest on short-term investments. Check if the calculations that the financial analyst submitted are correct and match your analysis. Chec that has a correct value. If a value is incorrect, do not check the corresponding box. bo: Step 1: Determining the initial investment outlay Schedule of Cash Flows Before Tax After Tax Check if Correct Investment Outlay -$56,515 -$80,736 Call premium on the old bond -$3,074 -$3,074 Flotation cost on new issue $2,436 $731 Immediate tax savings on old flotation cost expense -$58,858 Total after-tax investment 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 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 e$115.28 . 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 1o4.0. Ie ieL aiiUIuLauiuii tax eiiect U1 LIe IULaLiuin CUSL IS LIie uiierence Detweeii uie UIu aiiu LIne iew issue, which is per year for the next tax savings from amortizing the flotation costs wil years. If the company issues new bonds, the increase 3,71 or $8.70 $ 6.53 3 10.08 314.14 Step 3: Calculating the annual interest savings decrea se 1. The annual coupon payments on the old bonds were $100,920. Thus, the after-tax interest on the old $70, lo44.00 issue is $so, SIs.20 $ 42,380.4oor911 837.20 $42, 396.40, $9, 340.96, $38, 147.76, or 50,803, 68 2. The after-tax interest on the new bonds is 3. Thus, the net annual interest savings after tax will be $33,909, 12 28,257.601 536, 734.3, $31,063.30 0r At the final stage of the refunding analysis, you need to calculate the net present values (NPVS) of the savings and costs and the NPV of the entire refunding operation. Step 4: Calculating the NPV of the refunding Value Present value of amortized tax effects Present value of interest savings -$58,858 Net investment outlay NPV from refunding . neiuuung auaryDI n.18 Kefunding, Analysis $696,000, 14.50% Coupon, 10-year bond issue that was sold at par 3 years ago. The flotation cost on this issue was Consider yourself the CFO of ToughNut Corp. Management is considering whether the company should refund its $3,480 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 30 % , 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 New Bond Existing Bond $696,000 $696,000 Capital $3,074 $3,480 Flotation cost 8 10 Maturity 0 3 Years since issue 8.70% 14.50% Coupon 11.60% Call premium 6.09% After-tax cost of new debt The associate financial analyst on the finance team has done some preliminary refunding analysis and submitted the following calculations to you. Consider this as step 1 in the refunding analysis. Assume that the company pays no additional interest on the old issue and earns no interest on short-term investments. Check if the calculations that the financial analyst submitted are correct and match your analysis. Chec that has a correct value. If a value is incorrect, do not check the corresponding box. bo: Step 1: Determining the initial investment outlay Schedule of Cash Flows Before Tax After Tax Check if Correct Investment Outlay -$56,515 -$80,736 Call premium on the old bond -$3,074 -$3,074 Flotation cost on new issue $2,436 $731 Immediate tax savings on old flotation cost expense -$58,858 Total after-tax investment 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 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 e$115.28 . 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 1o4.0. Ie ieL aiiUIuLauiuii tax eiiect U1 LIe IULaLiuin CUSL IS LIie uiierence Detweeii uie UIu aiiu LIne iew issue, which is per year for the next tax savings from amortizing the flotation costs wil years. If the company issues new bonds, the increase 3,71 or $8.70 $ 6.53 3 10.08 314.14 Step 3: Calculating the annual interest savings decrea se 1. The annual coupon payments on the old bonds were $100,920. Thus, the after-tax interest on the old $70, lo44.00 issue is $so, SIs.20 $ 42,380.4oor911 837.20 $42, 396.40, $9, 340.96, $38, 147.76, or 50,803, 68 2. The after-tax interest on the new bonds is 3. Thus, the net annual interest savings after tax will be $33,909, 12 28,257.601 536, 734.3, $31,063.30 0r At the final stage of the refunding analysis, you need to calculate the net present values (NPVS) of the savings and costs and the NPV of the entire refunding operation. Step 4: Calculating the NPV of the refunding Value Present value of amortized tax effects Present value of interest savings -$58,858 Net investment outlay NPV from refunding