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XYZ Corp. is considering refunding its old debt now that interest rates have dropped. Old Bonds New Bonds Original...

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Finance

XYZ Corp. is considering refunding its old debt now thatinterest rates have dropped.

Old BondsNew Bonds
Original Life:10 Years5 Years
Par Value:1 Million1 Million
Coupon Rate:8 % annual6% annual
Call premium10%
Flotation Costs$40,000 original$45,000
Age of Bonds5 years0 years
Tax Rate 40%

Additionally, XYZ will have to borrow $1 million for 15 days(1/2 month) in order to cover itself between the time it buys backthe old debt and sells the new debt. The annualized interest rateon this short-term borrowing is 9 percent. Should XYZ perform therefunding?

Answer & Explanation Solved by verified expert
4.5 Ratings (864 Votes)
STEP1Discount Rate After Tax cost of new debtInterest rate for the new Bond600Flotation cost of new Bond as percentage450450001000000Before tax cost of new debt610045628Tax Rate 40After tax cost of new debt 628104377DISCOUNT RATE377STEP2Present Value PV of total outflowsInvestment OutlayCall Premium on    See Answer
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Transcribed Image Text

XYZ Corp. is considering refunding its old debt now thatinterest rates have dropped.Old BondsNew BondsOriginal Life:10 Years5 YearsPar Value:1 Million1 MillionCoupon Rate:8 % annual6% annualCall premium10%Flotation Costs$40,000 original$45,000Age of Bonds5 years0 yearsTax Rate 40%Additionally, XYZ will have to borrow $1 million for 15 days(1/2 month) in order to cover itself between the time it buys backthe old debt and sells the new debt. The annualized interest rateon this short-term borrowing is 9 percent. Should XYZ perform therefunding?

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