Deck 20: A: Financing with Derivatives

Question 1

Waste Deep Disposal Services are considering refunding a $525,000,000 bond issue.The old bonds have a 7.25% coupon rate.The new bonds will have a 6% coupon rate.Both issues will be outstanding for about four weeks.What is the overlapping interest if the company is in the 38% tax bracket (rounded)?

A)$1,517,465
B)$1,815,288
C)$1,357,642
D)$1,225,427

Answer 1

B
Explanation: 525,000,000(.0725)(.62)(4/52) = $1,815,288.46

Question 2

In a bond refunding analysis, the net investment calculation includes

A)aftertax call premium
B)flotation cost of new debt
C)overlapping interest
D)all of these

Answer 2

D

Question 3

Cutech issued a $150 million of a 20-year, 10.5% debt 5 years ago.Since then, Cutech's financial conditions have improved and management believes that they could refund the old issue with a new 15-year, 7.5% issue.The old debt is now callable at 104 percent of par and issuance costs on the new issue would be 0.6 percent.The unamortized issuance costs on the old issue are $675,000.If Cutech calls the old issue and refunds it, both issues would be outstanding for a two-week period.If the company's marginal tax rate is 40%, should Cutech refund the old issue?

A)Yes, NPV = $43,645,599
B)Yes, NPV = $43,798,975
C)Yes, NPV = $44,364,538
D)No, NPV is negative

Answer 3

B
Explanation:
Old interest = $150(.105) = $15.75 million
New interest = $150(.075) = 11.25
Interest saved $ 4.50 million
PV of savings = $4.50(PVIFA,₀₄₅.₁₅) = $48,328 million
Call premium = $6(1-.4) = $3.6 million
PV issuance = 900,000 - (900,000/15)(.4)(PVIFA,₀₄₅.₁₅) = 900,000 - 257,749 = $642,251
PV old issuance = (675,000/15)(.4)(PVIFA) - 675,000(.4) = 193,312 - 270,000 = -$76,688
Overlapping int. = $150(.063)(2/52) = $363,462
Net investment = 3,600,000 + 642,251 - 76,688 + 363,462 = 4,529,025
NPV refunding = 48,328,000 - 4,529,025 = $43,798,975

Question 4

Midget Digit Toe Doctors is planning to refund a 30 year bond issue.They will replace $1,500,000 of 10.25% bonds with 6.25% bonds.The firm is in the 40% tax bracket.What is the savings on the refunding?

A)$515,100
B)$646,310
C)$725,600
D)$815,170

Question 5

When considering bond refunding, all of the following are important input items EXCEPT:

A)interest payments of old issue
B)weighted cost of capital
C)interest payments of new issue
D)after-tax cost of debt

Question 6

Clinch River Power is considering refunding a $150 million 12% coupon bond with a 10% coupon bond, 20 year bond.The current bond also matures in 20 years and is now callable at 110% of par.The unamortized flotation cost on the old issue is $540,000 and the flotation cost of the new issue is 0.925%.Clinch River estimates that there would be a 4 week period where both bonds would be outstanding.The company has a weighted cost of capital of 11% and a 40% marginal tax rate.Should Clinch River sell the refunding issue?

A)Yes, NPV is approximately $9.838 million
B)Yes, NPV is approximately $9.930 million
C)Yes, NPV is approximately $9.655 million
D)Yes, NPV is approximately $10.808 million

Question 7

In considering the bond refunding analysis, which of the following statements is/are correct?

A)Only statement I is correct
B)Only statement II is correct
C)Both statements I and II are correct
D)Neither statement I nor II is correct

Question 8

Demetres is refunding an outstanding $75 million, 9.35% debenture with a $75 million 7.80% debenture.Both issues will be outstanding for a 3-week period.If Demetres' marginal tax rate is 40%, what is the overlapping interest?

A)$337,500
B)$242,740
C)$404,567
D)$202,500

Question 9

Why would a corporation consider bond refunding?

Question 10

Why is the after-tax cost of debt used in bond refunding analysis?

Question 11

When a bond is called, the old issue is retired and the bondholder receives:

A)new, lower interest rate bonds
B)new corporate stock
C)a cash payoff
D)treasury stock

Question 12

Bond occurs when a firm exercises its option to redeem a callable bond issue and replaces it with a lower (interest) cost issue.

A)redemption
B)retirement
C)recall
D)refunding

Question 13

What is the principal inflow and what is the principal outflow from a bond refunding situation?

Question 14

If interest rates decline, a firm should consider to take advantage of the lower interest rates.

A)selling fixed assets
B)stock sales
C)bond refunding
D)investing in marketable securities

Question 15

Wood River Power Company is considering refunding a $100 million 12% coupon debenture issue with a 9% coupon, 20-year debenture.The 12% issue also matures in 20 years and is now callable at 109% of par.The unamortized flotation cost on the old issue is $360,000 and the flotation cost of the new issue is 0.775%.Wood River estimated that there would be a 4 week period where both bonds would be outstanding.The company has a weighted cost of capital of 11% and a 40% marginal tax rate.Should Wood River sell the refunding issue? (Note: PVIFA0.054,20 = 12.050)

A)yes, NPV is approximately $15.21 million
B)yes, NPV is approximately $9.86
C)yes, NPV is approximately 6.485 million
D)No, NPV is negative $0.554 million

Question 16

In a bond refunding analysis, the principal benefit, or cash inflow, is the present value of the

A)pretax interest savings over the life of the issue
B)aftertax flotation cost savings
C)aftertax interest savings over the life of the issue
D)aftertax call premium

Question 17

If Alliant can issue a $110 million 20-year refunding bond at 7.45% and call an older $110 million issue with 20-years to maturity that had a coupon of 8.80%, what is the present value of the interest savings? Assume a 40% tax rate.

A)$11,620,259
B)$17,820,000
C)$ 9,117,935
D)$29,561,100

Question 18

Bond refunding occurs when a company redeems a callable issue and

A)sells an equity issue, thereby reducing outstanding debt
B)sells a new issue with a lower coupon rate
C)sells a preferred issue with a low dividend rate
D)none of these is correct

Question 19

In bond refunding analysis the is believed to be the most appropriate discount rate.

A)after-tax cost of new debt
B)firm's marginal cost of capital
C)weighted average cost of capital
D)both b and c