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Start with the partial model in the file Ch20 P06 Build a Model.xls on the textbook’s
Web site. Schumann Shoe Manufacturer is considering whether or not to refund a
$70 million, 10% coupon, 30-year bond issue that was sold 8 years ago. It is amortizing
$4.5 million of flotation costs on the 10% bonds over the issue’s 30-year life.
Schumann’s investment bankers have indicated that the company could sell a new
22-year issue at an interest rate of 8% in today’s market. Neither they nor Schumann’s
management anticipate that interest rates will fall below 6 percent anytime
soon, but there is a chance that interest rates will increase.
a. Perform a complete bond refunding analysis. What is the bond refunding’s
NPV?
b. At what interest rate on the new debt is the NPV of the refunding no longer
positive?
t is amortizing
Schumann’s
A
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Schumann Shoe Manufacturer is considering whether or not to refund a $70 million, 10% coupon, 30-year bond issue that
ago. It is amortizing $4.5 million of flotation costs on the 10% bonds over the issue's 30-year life. Schumann's investment
indicated that the company could sell a new 22-year issue at an interest rate of 8 percent in today's market. Neither they no
management anticipate that interest rates will fall below 6 percent any time soon, but there is a chance that interest rates w
A call premium of 10 percent would be required to retire the old bonds, and flotation costs on the new issue would amoun
Schumann's marginal federal-plus-state tax rate is 40 percent. The new bonds would be issued 1 month before the old bo
with the proceeds being invested in short-term government securities returning 5 percent annually during the interim perio
Current bond issue data
Par value
Coupon rate
Original maturity
Remaining maturity
Original flotation costs
Call premium
Tax rate
$
$
Refunding data
Coupon rate
Maturity
Flotation costs
$
Time between issuing new bonds and calling old bonds (months)
Rate earned on proceeds of new bonds before calling old bonds (annual)
70,000,000
10%
30
22
4,500,000
10%
40%
8.0000%
22
5,000,000
1
5%
a. Perform a complete bond refunding analysis. What is the bond refunding's NPV?
Initial investment outlay to refund old issue:
Call premium on old issue =
After-tax call premium =
New flotation cost =
Old flotation costs already expensed =
Remaining flotation costs to expense =
Tax savings from old flotation costs =
Additional interest on old issue after tax =
Interest earned on investment in T-bonds after tax =
Total investment outlay =
Annual Flotation Cost Tax Effects:
Annual tax savings on new flotation =
Tax savings lost on old flotation =
Total amortization tax effects =
Annual interest savings due to refunding:
Annual after tax interest on old bond =
You get to expense the remaining
This is interest paid on the old bo
This is interest earned on the pro
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A
B
Annual after tax interest on new bond =
Net after tax interest savings =
C
D
Annual cash flows =
After-tax cost of new debt =
NPV of refunding decision =
b. At what interest rate on the new debt is the NPV of the refunding no longer positive?
Use Goal Seek to set cell D60 to zero by changing cell C27.
"Break-even" interest rate =
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oupon, 30-year
bond issue that was sold 8 years
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ar life. Schumann's
investment bankers have
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today's market.
Neither they nor Schumann's
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is a chance
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on the new
13issue would amount to $5 million.
sued 1 month
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annually during
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the interim period.
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ou get to expense
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the remaining flotation costs
his is interest
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his is interest
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