Corporate Finance:
Chapter 5: Financing East Coast Yacht’s Expansion Plans with a Bond
1. If the company benefits from the provision of the bond, then the coupon rate will be higher. If the bondholder’s benefit, then the bond will have lower coupon rate.
a. Bond’s with collateral will have lower coupon rate as bondholders have claim on collateral no matter what. It provides an asset which lowers default risk. Downside to company is that this collateral cannot be sold as an asset and needs to maintain it.
b. The more senior the bond, the lower the coupon rate.
c. A sinking fund reduces coupon rate because it provides a kind of future guarantee to bondholders. The company must make payments into the sinking fund or default so it must
…show more content…
Coupon bond principal payment at maturity = 30,000($1,000) = $30,000,000
The principal payment for the zero coupon bonds at maturity will be:
Zero coupon bond payment at maturity = 139,827($1,000) = $139,827,000
4. Annual coupon bond payments = 30,000($1,000)(.08) = $2,400,000
Since the interest payments are tax deductible, the aftertax cash flow from the interest payments will be:
Aftertax coupon payments = $2,400,000(1 – .35) = $1,560,000
Even though interest payments are not actually made each year, the implied interest on the zero coupon bonds is tax deductible. The value of the zero coupon bonds next year will be:
Value of zero in one year = $1,000/1.0819 = $231.71
5. P = $40({1 – [1/(1 + .03)]26 } / .03) + $1,000[1 / (1 + .03)26] P = $1,178.77
And, if the Treasury rate is 9.10 percent, the make whole call price in 7 years is:
P = $40({1 – [1/(1 + .0475)]26 } / .0475) + $1,000[1 / (1 + .0475)26] P = $889.35
So, the growth on the zero coupon bond was:
Zero coupon growth = $231.71 – 214.55 = $17.26
This increase in value is tax deductible, so it reduces taxes even though there is no cash flow for interest payments. So, there is a positive cash flow created next year in the amount of:
Zero cash flow = 139,827($17.26)(.35) = $839,989.70
This cash flow will increase each year since the value of the zero coupon bond will increase by a greater dollar amount each year.
6. The
($372 + $135 + 500) / ($2.21 - ($0.83 + .40)) = 1,028 [+/- 31]
P = F(1 + i)-N where i is 15% as mentioned in the case suggestions and N is 8 as we found above, and F is $1.2375B
RE = [$1.30 × (1 + 0.060)] / $36.80 + 0.060 = 0.097446 = 9.74 percent (3)
| |One reason corporations sell corporate bonds is to help finance their ongoing business activities. |
$900 in interest payments received on the Municipal Bond, interest from municipal bonds are tax exempt ($5,000 bond multiplied by 9% interest = $450 semi-annually = $900)
| Consider a perpetuity that pays $100 every year. If the rate of discount is 7 percent, the present value of the bond isAnswer
In 5% interest rate, Mr. Smith’s original pension plan has the expected present value $157,044 at age 65. If he chooses a 10-year benefit, his revised benefit will be $978.17 per month, with
Corporate Bonds are the financial instruments through which corporates can raise capital by borrowing money from investors. In return company pays interest on the principal. And the principal is returned to the lender after pre-determine period also called as maturity. It is more cost effective to raise money through bonds than through equity. Even if the company is going through a difficult financial crisis, it still has a legal commitment to pay interest and principal to lenders. Bond investors have priority over shareholders on the company’s properties in case of bankruptcy. Companies issue bonds for a variety of purposes, including buying new assets, investing in research and development, refinancing debt, or financing mergers and acquisitions.
Q1 what are the annual cash outlays associated with the bond issue? The common stock
Each bond has a maturity value of $1,000, an annual coupon of 12.0%, and 15 years left to maturity. The bonds can be called at any time with a premium of $50 per bond. If the bonds are called, the company must pay flotation costs of $10 per new refunding bond. Ignore tax considerations--assume that the firm's tax rate is zero.
5. If debt is used to finance this project, should the interest payments associated with this new debt be considered cash flows?
∏i = (Pe + 40 - 100) x 100 = 100 x Pe –6,000 -------------------- [1]
The advantage of debt financing is that interests paid on such debt are tax deductible. If a company has the intention of maintaining a permanent debt, the present value of the tax shield can be obtained by discounting them by the expected rate of return demanded by the investors who hold the debt (this is a perpetuity, where in reality would be the maximum possible present value for the tax shield). This tax shield value reduces the tax bill and increases the cash payment to investors, increasing the value of their investments.
So, 1-.092= 90.8%. The WACC for P&S is WACC(P&S)= 9.2% (3.44%) + 90.8%(12.1%), which equals to 11.30%