Running head: COUPON AND BONDS

Coupon rates

Name

Institution
 COUPON AND BONDS

QUESTION ONE

Par value 150000000

Coupon rate 15%
Original maturity 30 years
Remaining 25years
maturity
Original 30000000
floatation costs
Call premium 10%
Tax rate 40%

NEW ISSUE
INFORMATIO
N
Coupon rate 10%
Maturity 25years
Floatation costs 6000000

Interim period 1 month

between issues
Rate for surplus 5%
For calculating the NPV of bond refunding, we have to

find the annual savings from issue of new bonds and also the initial outflow of funds:

Initial outflow of funds = Call premium on retiring old bonds + Flotation cost of new issue +

Interest on old bonds for interim period of one month

Call premium on old issue (after tax) = $150,000,000 * 15% *(1-0.40) = $13,500,000

Flotation cost of new issue = $6,000,000

Interest on old issue for interim period = $150,000,000 * 15% * 1/12 * (1 - 0.40) = $1125000

Initial Outflow of funds = $13,500,000 + $6,000,000 + $1125000 = $20,625000

 COUPON AND BONDS

Intial savings due to new issue = Tax savings on flotation cost of old bonds + Interest on

investment in government security for interim period

Remaining Flotation cost of old bonds = ($3,000,000/30) * 25 = $2,500,000

Tax savings on flotation cost of old bonds = $2,500,000 * 0.40 = $1000000

Interest on investment in government security for interim period = {$15000,000 * 5% * (1-

0.40)} / 12 = $375000

Intial savings due to new issue = $1,000,000 + $375,000 = $1375000

Net intital outlay = $20625000 - $1375000 = $19250000

Annual inflow = Annual interest savings + Annual tax savings on amortization of flotation cost

Annual post tax interest on new bonds = $150,000,000 * 10% * (1 - 0.40) = $9000000

Annual post tax interest on old bonds = $150,000,000 * 15% * (1- 0.40) = $13500000

Annual interest savings = $13500000 - $9000000 = $4500000

Tax savings on amortisation of flotation cost of new bonds = ($6,000,000 / 25) * 0.40 = $96000

Tax savings on amortisation of flotation cost of old bonds = ($3,000,000 / 30) * 0.40 = $40,000

Net Tax savings on amortisation of flotation cost = $96,000 - $40,000 = $56,000

Annual inflow = $4500,000 + $18,000 = $4518000

Present value of annual inflows discounted at 5% for 25 years =

4518000*14.0939=$63,676,240.02

NPV = - $19250000 + $63,676,240.02= $44426240.02