Intermediate Financial Management (with Thomson One)

Table 18-3
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43
44
45
46
47
48
49
50
51
52
53
54
55
56
57
58
59
60
61
62
642 • Part 5 Tactical Financing Decisions
Spreadsheet for the Bond Refunding Decision (IFM9 Ch18 Tool Kit.xls)
A
Input Data (in thousands of dollars)
Existing bond issue
Original flotation cost
Maturity of original debt
Years since old debt issue
Call premium (%)
Original coupon rate
After-tax cost of new debt
Schedule of cash flows
Investment Outlay
Call premium on the old bond
Flotation costs on new issue
Immediate tax savings on old flotation cost expense
Extra interest paid on old issue
Interest earned on short-term investment
Total after-tax investment
Annual Flotation Cost Tax Effects: t = 1 to 20
Annual tax savings from new issue flotation costs
Annual lost tax savings from old issue flotation costs
Net flotation cost tax savings
Annual Interest Savings Due to Refunding: t = 1 to 20
Interest on old bond
Interest on new bond
Net interest savings
Since the annual flotation cost tax effects and interest savings occur for the next 20 years, they represent
annuities. To evaluate this project, we must find the present values of these savings. Using the function
wizard and solving for present value, we find that the present values of these annuities are:
Calculating the annual flotation cost tax effects and the annual interest savings
Annual Flotation Cost Tax Effects
Maturity of the new bond (Nper)
After-tax cost of new debt (Rate)
Annual flotation cost tax savings (Pmt)
NPV of annual flotation cost savings
Hence, the net present value of this bond refunding project will be the sum of the initial outlay and the present
values of the annual flotation cost tax effects and interest savings.
Bond Refunding NPV = Initial Outlay + PV of flotation costs + PV of interest savings
Bond Refunding NPV =
Bond Refund NPV =
B C
D
E
F
G H I
($5,470)
$7,604,425
$60,000
$3,000
25
5
10%
12%
5.4%
20
5.4%
$5
$60
New bond issue
New flotation cost
New bond maturity
New cost of debt
Tax rate
Short-term interest rate
Before-tax After-tax
($6,000)
$60,000
Row 28. Flotation costs on old issue: The old issue has an unamortized flotation
cost of (20/25)($3,000,000) $2,400,000 at this time. If the issue is retired, the
unamortized flotation cost may be recognized immediately as an expense, thus
creating an after-tax savings of $2,400,000(T) $960,000. Because this is a cash
inflow, it is shown as a positive number in Row 28.
Rows 29 and 30. Additional interest: One month’s “extra” interest on the old
issue, after taxes, costs $360,000:
(2,650)
2,400
(600)
300
$133
(120)
$13
$7,200
(5,400)
$1,800
($3,600)
(2,650)
960
(360)
180
($5,470)
$53
(48)
$5
$4,320
(3,240)
$1,080
Annual Interest Savings
Maturity of the new bond (Nper)
After-tax cost of new debt (Rate)
Annual interest savings (Pmt)
NPV of annual interest savings
+ $60 +
$13,014
$2,650
20
9%
40%
6%
20
5.4%
$1,080
$13,014