Solution fundamentals of corporate finance brealy 4th chapter text solutions ch 13

Solutions for Chapter 13 An Overview of Corporate Financing a Authorized share capital = 100,000 Presently 20,000 shares are issued and outstanding So 80,000 more shares can be issued without approval of shareholders b After new issue; Book value of common stockholders’ equity (figures in thousands) Common Shares $110 Retained Earnings 30 Net Common Equity 140 Note: 100 Authorized Shares 30 Issued Shares The cost of the share repurchase is $5 x 1000 = $5,000 If the average issue price of these share was $ 5, the common shares account would be reduced by $5,000 The company’s accounts in the books would appear as follows: Common shares Retained earnings Net common equity $ 55,000 30,000 85,000 13-1 Copyright © 2006 McGraw-Hill Ryerson Limited a b c d e f g h i j k Funded Eurobond Subordinated Sinking fund Call Prime rate Floating rate Private placement, public issue Lease Convertible Warrant a b c True False True Preferred stock is like long-term debt in that it commits the firm to paying the security holder a fixed sum — either a specified coupon payment in the case of bonds or a specified dividend in the case of preferred stock Like equity and unlike debt, however, failure to pay the dividend on preferred stock does not set off bankruptcy a Under majority voting, the shareholder can cast 90 votes for a favorite candidate b Under cumulative voting with 10 candidates, the shareholder can cast 10 x 90 = 900 votes for a favorite candidate a Under majority voting, each candidate is voted on in a separate election To ensure that your candidate is elected, you need to own at least half the shares, which is 200,000 shares (or 200,001 shares to ensure a strict majority of the votes) b Under cumulative voting, all candidates will be voted on at once, and there will be × 400,000 = 2,000,000 votes cast If your candidate receives onefifth of the votes, he or she will place at least fifth in the balloting and will be elected to the board Therefore, you would need to cast 400,000 votes for your candidate, which would require that you own 80,000 shares a Common shares will go up by 10 million shares x $55 per share = $550 million The accounts will appear as follows: 13-2 Copyright © 2006 McGraw-Hill Ryerson Limited Book value of common stockholders’ equity of George Weston Limited (figures in millions) Common Shares $670 Retained Earnings 4,046 Foreign Currency Translation Adjustments (192) Net Common Equity 4,524 b The cost of the share repurchase to George Weston is $60 x 500,000 = $30,000,000 If the average issue price of these shares is $30, common shares will be reduced by $30 x 500,000 = $15,000,000 The rest of the reduction is to retained earnings: $15 x 500,000 = $15,000,000 Common shareholders’ equity is now arrived at as follows: (figures in millions) Common Shares (670 - 15) $655 Retained Earnings (4,046 - 15) 4,031 Foreign Currency Translation Adjustments (192) Net Common Equity 4,494 Lease obligations are like debt in that both legally obligate the firm to make a series of specified payments Bondholders would like the firm to limit lease obligations for the same reason that they desire limits on debt: to keep the firm’s financial burden at manageable levels and make the already existing debt safer 10 a A call provision gives the firm a valuable option It will require the firm to compensate the investor by promising a higher yield to maturity b A restriction on further borrowing protects bondholders They will therefore require a lower yield to maturity 13-3 Copyright © 2006 McGraw-Hill Ryerson Limited c Collateral also protects the bondholder and results in a lower yield to maturity d The option to convert gives the bondholders a valuable option They will therefore be satisfied with a lower promised yield to maturity 11 Income bonds are like preferred stock in that the firm promises to make specified payments to the security holder If the firm cannot make those payments, however, the firm is not forced into bankruptcy The advantage of income bonds over preferred stock is that the interest payments are tax-deductible expenses 12 In general, the fact that preferred stock has lower priority in the event of bankruptcy reduces its price and increases its yield compared to bonds; on the other hand, the fact that the dividend payments are free of taxes to corporate holders increases the price and reduces the yield at which preferred stock trades For strong firms, the default premium will be small and the tax effect will dominate, so the preferred will have a lower yield than the bonds For weaker firms the default premium will dominate 13 From Alcan’s Annual Report for 2003, we get the following: Equity • • • • 14 Debt (note 19) • • • • • • Redeemable preference shares Common shares Contributed surplus Retained earning Commercial paper Debentures Bank loans Global notes Euro medium term notes Bonds Bell Canada’s annual report can be accessed through its website at http://www.bce.ca/data/documents/BCE_annual_2004.pdf To answer the question, this site was accessed in August, 2005 • Book value of common equity 2004 – $ 16.781 billion (2004 Annual ReportBalance Sheet) • Common shares outstanding for 2003 – 923,988,818 and 2004 -925,935,682 (Note 21 of the 2004 Annual Report) 13-4 Copyright â 2006 McGraw-Hill Ryerson Limited 15 Bell Canada has raised money in a variety of ways, including plowing back earnings (through an increase in retained earnings) and issuing new common shares In 2004, the company raised money through retained earnings (2004 – increase by $55 million), than through the issue of common shares ($32 million) (See cash flow statement) Alcan • Long-term debt-to-equity (Book – in millions of US$) 2002 - 3,196/8,465 =0.38 2003 - 7,604/10,555= 0.72 Note: Equity =common shareholders’ equity • Long term debt-to-equity (Market Value) = long-term debt/ (average price per share x average shares outstanding) Note: Average shares outstanding at year end taken from Annual Report (in millions)2003=365.81 and 2002 =321.470 (Note 21) Average Stock Price 2003 =US$34.53, 2002= US$33.44 For each year, average stock price was computed as monthly closing prices/12) Monthly closing price taken from Yahoo Finance Market value of equity and long-term debt are quoted in U.S $ 2002- Long-term debt (market value) = 3,196/ 10,750 = 0.30 2003- Long-term debt (market value) = 7,604/ 12,610 = 0.60 (Here, the numerator is comprised of the book value of long-term debt) 16 INCO LTD - For year ending December 31, 2004 USES OF FUNDS • Capital Expenditure • Preferred dividends • Reduction of long term debt SOURCES OF FUNDS • Long-term borrowing • Common preferred shares issued FALCONBRIDGE LTD-For year ending December 31, 2004 USES OF FUNDS • Capital investment 13-5 Copyright â 2006 McGraw-Hill Ryerson Limited Long term debt reduction • Dividend paid SOURCES OF FUNDS • Long term debt • Common and preferred shares issued • Sale of investment Notice the similarity in the financing patterns of the two companies 17 a) Anheuser-Busch’s internal source of funds includes; retained earnings, and equity issues External source – debt financing Anheuser-Busch’s primary use of funds during 2001 – 2003 include; capital expenditure and new business acquisitions (Cash Flow Statement 2003) b) Long-term debt-to-equity (book value -US$million) • 2003 – 2.69 (7,285.4/2711.7) • 2002 – 2.16 (6,60.2/3,052.3) • 2001 – 1.47 (5,983.9/4,061.5) Long-term debt-to-equity (market value- US$million) • 2003 – 0.18 (7,285.4/40,695.7) • 2002 – 0.15 (6,603.2/43,083.5) • 2001 – 0.16 (5,983.9/37,877.7) • Long term debt-to-equity (Market Value) = Book value of long-term debt/ (average price per share x average shares outstanding) Note: • Monthly closing price taken from Yahoo Finance • Average shares outstanding at year end taken from Annual Report(in million) 2003=813.1, 2002=846.6, 2001= 879.1 • Average Stock Price 2003=US$50.05, 2002=US$50.89, 2001= US$43.03( monthly closing price/12) • Market value of equity and long-term debt are quoted in U.S $ • Long-term debt/common equity Using market value of equity the long-term debt-to-equity has improved significantly for Anheuser-Busch This is due to higher market value of equity 13-6 Copyright © 2006 McGraw-Hill Ryerson Limited c i) For example, Big Rock Brewery’s internal source of financing includes retained earnings and equity issues External source of financing – long term debt Big Rock Brewery’s primary use of funds – capital expenditure ii) Long term debt –to- equity (Book - US$ million) 2003 - 1.754/20.65 = 0.085 2002 - 0.941/13.65 = 0.069 2001 - 2.199/12.06 = 0.182 Long term debt-to-equity (market value) 2003 - 1.754/39.47= 0.04 2002 - 0.941/24.95=0.04 2001 - 2.199/24.94=0.09 Note: • Monthly closing price taken from Yahoo Finance • Average shares outstanding at year end taken from Annual Report(in millions) 2003=5.542, 2002=5.242, 2001= 4.909 • Average Stock Price 2003=7.05, 2002=4.76, 2001= 5.08(monthly closing price/12) • Market value of equity and long-term debt are quoted in U.S $ • Long-term debt/common equity Note: Big Rock Brewery’s fiscal year ended in March until 2003 when it switched to a calendar year The ratios for 2001 to 2003 use the March fiscal year-end 13-7 Copyright © 2006 McGraw-Hill Ryerson Limited Appendix 13A: Practice Problem Solutions Before making the bond refunding decision, we calculate the present value of the net investment cost for E-Books.com by following the steps below: Call premium = 0.05 x $1,000,000 = $50,000 The annual tax deduction on flotation cost of new issue = $25,000/5 = $5,000 The annual tax savings over years will be 0.25 x $5,000 = $1,250 After-tax cost of new debt = 9.0% (1- 0.25) = 6.75% The present value of the tax savings on the flotation cost is computed by applying the annuity formula as follows:       1 −    1.0675      The present value of the tax savings = $1,250 ×   0.0675     = $5,160 The net after-tax flotation cost on the new issue is calculated as follows: Gross flotation costs on new issue $ 25,000 Present value of associated tax savings - 5,160 Net after-tax flotation cost on new issue $19,840 1  The additional interest cost on the old issue = $1,000,000 ×  × 0.11 × (1 − 0.25)  12  = $6,875 Since E-Books.com can invest the proceeds from the new issue in the money market for one month, we consider the after-tax interest E-Books.com would earn 1  After-tax interest earned = $1,000,000 ×  × 0.05  × (1 − 0.25)  12  = $3,125 Now, we compute the net after-tax additional interest cost to E-Books.com: after-tax additional interest paid on the old issue the after-tax interest earned on the new issue The net after-tax additional interest cost 13-8 Copyright © 2006 McGraw-Hill Ryerson Limited $6,875 - 3,125 $3,750 The total present value of the net investments costs associated with the refunding decision is provided below: 13-9 Copyright © 2006 McGraw-Hill Ryerson Limited Call premium Net after-tax flotation cost on new issue Net after-tax additional interest Total present value of net investment costs $50,000 19,840 + 3,750 $73,590 We consider the net savings from refunding Therefore, we first compute the following: The annual after-tax interest cost on the old issue: = $1,000,000 x 0.11 x (1- 0.25) = $82,500 The annual after-tax interest cost on the new issue: = $1,000,000 x 0.09 x (1-0.25) = $67,500 The yearly interest saving from going forward with refunding is $82,500 - $67,500 = $15,000 To find the present value of this stream of yearly savings, we, once again, discount the annuity by the after-tax interest cost of the new issue The present value of the net savings from refunding:    1 −   1.0675   = $15,000 ×  0.0675   = $61,917           Finally, we calculate the net present value from bond refunding PV of net savings over years PV of net investment cost NPV of bond refunding $61,917 - 73,590 ($11,673) Since NPV is negative, E-Books.com should not refund the bond issue Rate Time period Dollar amount ($) (years) Outstanding bond issue Coupon interest rate on old issue 1,000,000 1,000,000 11% New bond issue Coupon interest rate on new issue 9.0% After-tax coupon interest rate on new issue 6.8% Short-term investment yield per annum 5.0% 13-10 Copyright © 2006 McGraw-Hill Ryerson Limited Rate Time period Dollar amount ($) (years) Marginal tax rate 25% Present Value of Net Investment Costs Call premium on outstanding bond issue 5% 50,000 Rate Time period Dollar amount ($) (years) 25,000 Flotation cost on new issue Flotation cost amortized for tax purposes 1-5 5,000 Annual tax savings 1-5 1,250 PV of tax savings on flotation costs 5,160 Net after-tax flotation cost on new issue 19,840 Additional interest cost on old issue 6,875 Interest earned on S-T investment of new issue (after tax) Net after-tax additional interest 3,125 3,750 Total PV of after-tax investment costs 73,590 Annual after tax interest on old issue 1-5 82,500 Annual after tax interest on new issue 1-5 67,500 Net annual savings in interest cost 1-5 15,000 PV of total interest cost savings over years 61,917 Net Present Value (NPV) from bond refunding -11,673 Net Savings from Refunding Since the NPV is negative, E-Books.com concludes that it will not be profitable for the firm to refund the existing bond issue at this time We calculate the present value of the net investment cost as follows: Call premium = 0.07 x $10,000,000 = $700,000 13-11 Copyright © 2006 McGraw-Hill Ryerson Limited The annual tax deduction on flotation cost of new issue = $150,000/5 = $30,000 The annual tax savings over years will be 0.35 x $30,000 = $10,500 After-tax cost of new debt = 9.0% (1- 0.35) = 5.85% The present value of the tax savings on the flotation cost is computed by applying the annuity formula as follows:       1 −    0585     The present value of the tax savings = $10,500 ×    0.0585     = $44,411 13-12 Copyright © 2006 McGraw-Hill Ryerson Limited The net after-tax flotation cost on the new issue is calculated as follows: Gross flotation costs on new issue $ 150,000 Present value of associated tax savings - 44,411 Net after-tax flotation cost on new issue $105,589 The additional interest cost on the old issue: 1  = $10,000,000 ×  × 0.12  × (1 − 0.35)  12  = $65,000 Since Food-Galore can invest the proceeds from the new issue in the money market for one month, we consider the after-tax interest E-Books.com would earn 1  After-tax interest earned = $10,000,000 ×  × 0.10  × (1 − 0.35)  12  = $54,167 Now, we can calculate the net after-tax additional interest cost to Food-Galore as follows: After-tax additional interest paid on the old issue $65,000 The after-tax interest earned on the new issue - 54,167 The net after-tax additional interest cost $10,833 We can now arrive at the total present value of the net investments cost of refunding Call premium $700,000 Net after-tax flotation cost on new issue 105,589 Net after-tax additional interest + 10,833 Total present value of net investment costs $816,422 Now, we must consider the net savings from refunding Therefore, we must first calculate the following: The annual after-tax interest cost on the old issue = $10,000,000 x 0.12 x (10.35) = $780,000 The annual after-tax interest cost on the new issue = $10,000,000 x 0.09 x (1-0.35) = $585,000 Therefore, the yearly interest saving from going forward with refunding is $780,000 - $585,000 = $195,000 To find the present value of this stream of yearly savings, we, once again, discount the annuity by the after-tax interest cost of the new issue 13-13 Copyright © 2006 McGraw-Hill Ryerson Limited The present value of the net savings from refunding:    1 −  20   1.0585 = $195,000 ×   0.0585   = $2,264,127           Finally, we calculate the net present value from bond refunding: PV of net savings over years PV of net investment cost NPV of bond refunding $2,264,127 - 816,422 $1,447,705 Since the NPV is positive, Food-Galore should go forward with the bond refunding activities Rate Time period Dollar amount ($) (years) Outstanding bond issue 10,000,000 10,000,000 700,000 150,000 Flotation cost amortized for tax purposes 1-5 30,000 Annual tax savings 1-5 10,500 PV of tax savings on flotation cost 44,411 Net after-tax flotation cost on new issue 105,589 Coupon interest rate on old issue 12% New bond issue Coupon interest rate on new issue 9.0% After-tax coupon interest rate on new issue 5.9% Short-term investment yield per annum 10% Marginal tax rate 35% Present Value of Net Investment Costs Call premium on outstanding bond issue 7.0% Flotation cost on new issue 13-14 Copyright © 2006 McGraw-Hill Ryerson Limited Additional interest cost on old issue 65,000 Interest earned on S-T investment of new issue (after tax) Net after-tax additional interest 54,167 10,833 Total PV of after-tax investment costs 816,422 Annual after tax interest on old issue 1-20 780,000 Annual after tax interest on new issue 1-20 585,000 Net Savings from Refunding Rate Time period Dollar amount ($) (years) 1-20 195,000 Net annual savings in interest cost PV of total interest cost savings over 20 years 2,264,127 Net Present Value (NPV) from bond refunding 1,447,705 Since the NPV is positive, Food Galore Inc concludes that it will be profitable for the company to refund the existing bond issue The present value of the net investment cost is computed as follows: Call premium = 0.12 x $100,000,000 = $12,000,000 The annual tax deduction on flotation cost of new issue = $5,000,000/5 = $1,000,000 The annual tax savings over years will be 0.35 x $1,000,000 = $350,000 After-tax cost of new debt = 10% (1- 0.35) = 6.5% The present value of the tax savings on the flotation cost is computed as follows:       1 −     1.065      The present value of the tax savings = $350,000 ×   0.065     = $1,454,488 The net after-tax flotation cost on the new issue is calculated as follows: Gross flotation costs on new issue 13-15 Copyright © 2006 McGraw-Hill Ryerson Limited $ 5,000,000 Present value of associated tax savings Net after-tax flotation cost on new issue - 1,454,488 $3,545,512 The additional interest cost on the old issue: 1  = $100,000,000 ×  × 0.14  × (1 − 0.35)  12  = $758,333 Food-Galore can invest the proceeds from the new issue in the money market for one month The after-tax interest E-Books.com would earn is: 1  After-tax interest earned = $100,000,000 ×  × 0.06  × (1 − 0.35)  12  = $325,000 The net after-tax additional interest cost is: After-tax additional interest paid on the old issue The after-tax interest earned on the new issue The net after-tax additional interest cost $758,333 - 325,000 $433,333 We now arrive at the total present value of the net investments cost of refunding Call premium Net after-tax flotation cost on new issue Net after-tax additional interest Total present value of net investment costs $12,000,000 3,545,512 + 433,333 $15,978,845 Now, we must consider the net savings from refunding Therefore, we must first calculate the following: The annual after-tax interest cost on the old issue: = $100,000,000 x 0.14 x (1- 0.35) = $9,100,000 The annual after-tax interest cost on the new issue: = $100,000,000 x 0.10 x (1-0.35) = $6,500,000 Therefore, the yearly interest saving from going forward with refunding is $9.1 million - $6.5 million = $2.6 million To find the present value of this stream of yearly savings, we, once again, discount the annuity by the after-tax interest cost of the new issue The present value of the net savings from refunding: 13-16 Copyright © 2006 McGraw-Hill Ryerson Limited    1 −  20  1.065   = $2,600,000 ×  0.065   = $28,648,119           Finally, we can now calculate the net present value from bond refunding by taking the difference between the present value of the net savings and the present value of the net investment cost PV of net savings over years PV of net investment cost NPV of bond refunding $28,648,119 - 15,978,845 $12,669,274 Since the NPV is positive, Universal Heavy Equipment should go forward with the bond refunding activities at this time Rate Time period Dollar amount ($) (years) Outstanding bond issue 100,000,000 100,000,000 12,000,000 5,000,000 Flotation cost amortized for tax purposes 1-5 1,000,000 Annual tax savings 1-5 350,000 Coupon interest rate on old issue 14% New bond issue Coupon interest rate on new issue 10.0% After-tax coupon interest rate on new issue 6.5% Short-term investment yield per annum 6.0% Marginal tax rate 35% Present Value of Net Investment Costs Call premium on outstanding bond issue 12% Flotation cost on new issue 13-17 Copyright © 2006 McGraw-Hill Ryerson Limited PV of tax savings on flotation cost 1,454,488 Net after-tax flotation cost on new issue 3,545,512 Additional interest cost on old issue 758,333 Interest earned on S-T investment of new issue (after tax) Net after-tax additional interest 325,000 433,333 Total PV of after-tax investment costs 15,978,846 Annual after tax interest on old issue 1-20 9,100,000 Annual after tax interest on new issue 1-20 6,500,000 Net annual savings in interest cost 1-20 2,600,000 PV of total interest cost savings over 20 years 28,648,119 Net Present Value (NPV) from bond refunding 12,669,273 Net Savings from Refunding Since the NPV is positive, Universal Heavy Equipment concludes that it will be profitable for the company to refund the existing bond issue Detailed Formula Inserts for the Excel Spreadsheet used in Practice Problem A Outstanding bond issue Coupon interest rate on old issue New bond issue Coupon interest rate on new issue After-tax coupon interest rate on new issue B Rate C D Time period Dollar amount ($) (years) 100000000 0.14 0.1 =B5*(1-B8) 13-18 Copyright © 2006 McGraw-Hill Ryerson Limited 100000000 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Short-term investment yield per 0.06 annum Marginal tax rate 0.35 Present Value of Net Investment Costs Call premium on outstanding bond 0.12 issue Flotation cost on new issue Flotation cost amortized for tax purposes Annual tax savings PV of tax savings on flotation cost Net after-tax flotation cost on new issue Additional interest cost on old issue Interest earned on S-T investment of new issue (after tax) Net after-tax additional interest Total PV of after-tax investment costs (D10 + D15 + D18) Net Savings from Refunding Annual after tax interest on old issue Annual after tax interest on new issue Net annual savings in interest cost PV of total interest cost savings over 20 years Net Present Value (NPV) from bond refunding =D2*B10 1-5 5000000 =D11/5 1-5 0 =D12*B8 =D13*(1-(1/(B6+1)^5))/B6 =D11-D14 0 =D2*(1/12*B3)*(1-B8) =D4*(1/12*B7)*(1-B8) 0 =D16-D17 =D10+D15+D18 1-20 =D2*B3*(1-B8) 1-20 =D4*B5*(1-B8) 1-20 =D21-D22 =D23*(1-(1/ (B6+1)^20))/B6 =D24-D19 The present value of the net investment cost with Canada call feature is computed as follows: Price of a bond = 140(PVIFA 10%, 20) + {1000/ (1+r) 20 = 140(8.5136) + {1000/ (1.10) 20 = 1191.90 + 148.64 = $ 1,340.54 Call premium per bond = price per bond – par value of bond = 1,340.54 – 1000.00 = $ 340.54 Total Call Premium = 340.54 X 100,000 = $ 34,054,000 The annual tax deduction on flotation cost of new issue = $5,000,000/5 = $1,000,000 13-19 Copyright © 2006 McGraw-Hill Ryerson Limited The annual tax savings over years will be 0.35 x $1,000,000 = $350,000 After-tax cost of new debt = 10% (1- 0.35) = 6.5% The present value of the tax savings on the flotation cost is computed as follows:       1 −    065     The present value of the tax savings = $350,000 ×    0.065     = $1,454,488 The net after-tax flotation cost on the new issue is calculated as follows: Gross flotation costs on new issue Present value of associated tax savings Net after-tax flotation cost on new issue $ 5,000,000 - 1,454,488 $3,545,512 The additional interest cost on the old issue: 1  = $100,000,000 ×  × 0.14  × (1 − 0.35)  12  = $758,333 Food-Galore can invest the proceeds from the new issue in the money market for one month The after-tax interest E-Books.com would earn is: 1  After-tax interest earned = $100,000,000 ×  × 0.06  × (1 − 0.35)  12  = $325,000 The net after-tax additional interest cost is: After-tax additional interest paid on the old issue The after-tax interest earned on the new issue The net after-tax additional interest cost $758,333 - 325,000 $433,333 We now arrive at the total present value of the net investments cost of refunding Call premium Net after-tax flotation cost on new issue Net after-tax additional interest Total present value of net investment costs $34,054,000 3,545,512 + 433,333 $38,032,845 Now, we must consider the net savings from refunding Therefore, we must first calculate the following: 13-20 Copyright © 2006 McGraw-Hill Ryerson Limited The annual after-tax interest cost on the old issue: = $100,000,000 x 0.14 x (1- 0.35) = $9,100,000 The annual after-tax interest cost on the new issue: = $100,000,000 x 0.10 x (1-0.35) = $6,500,000 Therefore, the yearly interest saving from going forward with refunding is $9.1 million - $6.5 million = $2.6 million To find the present value of this stream of yearly savings, we, once again, discount the annuity by the after-tax interest cost of the new issue The present value of the net savings from refunding:    1 −  20  1.065   = $2,600,000 ×  0.065   = $28,648,119           Finally, we can now calculate the net present value from bond refunding by taking the difference between the present value of the net savings and the present value of the net investment cost PV of net savings over years PV of net investment cost NPV of bond refunding $28,648,119 - 38,032,845 - $9,384,726 Since the NPV is negative, Universal Heavy Equipment should not go forward with the bond refunding activities at this time A Outstanding bond issue Par Value per bond 13-21 Copyright © 2006 McGraw-Hill Ryerson Limited B C Rate Time period (years) D Dollar amount ($) 100,000,000 1,000 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 Coupon interest rate on old issue New bond issue Coupon interest rate on new issue After-tax coupon interest rate on new issue Short-term money market investment yield Marginal tax rate Present Value of Net Investment Costs Call price per bond Call premium per bond Call premium on outstanding bond issue Flotation cost on new issue Flotation cost amortized for tax purposes Annual tax savings on amortized flotation cost PV of tax savings on flotation cost Net after-tax flotation cost on new issue Additional interest cost on old issue Interest earned on S-T investment of new issue (after tax) Net after-tax additional interest Total PV of after-tax investment costs (D13 + D18 + D21) Net Savings from Refunding Annual after tax interest on old issue Annual after tax interest on new issue Net annual savings in interest cost PV of total interest cost savings over 15 years Net Present Value (NPV) from bond refunding (D27- D22) A 14% 10.0% 6.5% 6.0% 35% 1340.54 B 13-22 Copyright © 2006 McGraw-Hill Ryerson Limited 100,000,000 C 1-5 1-5 0 0 0 340.54 34,054,000 5,000,000 1,000,000 350,000 1,454,488 3,545,512 758,333 325,000 433,333 38,032,846 1-20 1-20 1-20 0 9,100,000 6,500,000 2,600,000 28,648,119 -9,384,727 D 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 Rate Outstanding bond issue Par Value per bond Coupon interest rate on old issue New bond issue Coupon interest rate on new issue After-tax coupon interest rate on new issue Short-term money market investment yield Marginal tax rate Present Value of Net Investment Costs Time period (years) Dollar amount ($) 100000000 1000 0.14 100000000 0.1 =B6*(1-B9) 0.06 0.35 Call price per bond Call premium per bond Call premium on outstanding bond issue Flotation cost on new issue Flotation cost amortized for tax purposes Annual tax savings on amortized flotation cost PV of tax savings on flotation cost Net after-tax flotation cost on new issue Additional interest cost on old issue Interest earned on S-T investment of new issue (after tax) Net after-tax additional interest Total PV of after-tax investment costs (D13 + D18 + D21) Net Savings from Refunding Annual after tax interest on old issue Annual after tax interest on new issue Net annual savings in interest cost PV of total interest cost savings over 15 years Net Present Value (NPV) from bond refunding (D27 - D22) 13-23 Copyright © 2006 McGraw-Hill Ryerson Limited =(B4*D3)*(1-(1/1.1)^20/0.1) +1000/(1.1)^20 1-5 1-5 0 =D11-D3 =D12*D2/D3 2500000 =D14/5 =D15*B9 =D16*(1-(1/(B7+1)^5))/B7 =D14-D17 =D2*(1/12*B4)*(1-B9) 0 =D5*(1/12*B8)*(1-B9) =D19-D20 =D13+D18+D21 1-20 1-20 1-20 0 =D2*B4*(1-B9) =D5*B6*(1-B9) =D24-D25 =D26*(1-(1/(B7+1)^20))/B7 =D27-D22 ... comprised of the book value of long-term debt) 16 INCO LTD - For year ending December 31, 2004 USES OF FUNDS • Capital Expenditure • Preferred dividends • Reduction of long term debt SOURCES OF FUNDS... difference between the present value of the net savings and the present value of the net investment cost PV of net savings over years PV of net investment cost NPV of bond refunding $28,648,119 -... difference between the present value of the net savings and the present value of the net investment cost PV of net savings over years PV of net investment cost NPV of bond refunding $28,648,119 -