Chapter 5: 11DQ (page 524)
How does the bond rating affect the interest rate paid by a corporation on its bonds?
Bond ratings impact the interest paid by a corporation in a specific manner. The interest rate determination is dependent upon the level of rating. High-rated bonds carry less interest and vice versa.
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What are the disadvantages to being public?
Question: Barton Simpson, the chief financial officer of Broadband Inc. could hardly believe the change in interest rates that had taken place over the last few months. The interest rate on A2 rated bonds was now 6 percent. The $30 million, 15-year bond issue that his firm has outstanding was initially issued at 9 percent five years ago. Because interest rates had gone down so much, he was considering refunding the bond issue. The old issue had a call premium of 8 percent. The underwriting cost on the old issue had been 3 percent of par, and on the new issue it would be 5 percent of par. The tax rate would be 30 percent and a 4 percent discount rate would be applied for the refunding decision. The new bond would have a 10-year life. Before Barton used the 8 percent call provision to reacquire the old bonds, he wanted to make sure he could not buy them back cheaper in the open market.
c. Now do the standard bond refunding analysis as discussed in this chapter. Is the refunding financially feasible?
What method of “bond repayment” reduces debt and increases the amount of common stock outstanding? (LO16-3)
American Health Systems currently has 6,400,000 shares of stock outstanding and will report earnings of \(10 million in the current year. The company is considering the issuance of 1,700,000 additional shares that will net \)30 per share to the corporation.
a. What is the immediate dilution potential for this new stock issue?
b. Assume that American Health Systems can earn 9 percent on the proceeds of the stock issue in time to include them in the current year’s results. Calculate earnings per share. Should the new issue be undertaken based on earnings per share?
Question: The Bowman Corporation has a \(18 million bond obligation outstanding, which it is considering refunding. Though the bonds were initially issued at 10 percent, the interest rates on similar issues have declined to 8.5 percent. The bonds were originally issued for 20 years and have 10 years remaining. The new issue would be for 10 years. There is a 9 percent call premium on the old issue. The underwriting cost on the new \)18,000,000 issue is \(530,000, and the underwriting cost on the old issue was \)380,000. The company is in a 35 percent tax bracket, and it will use an 8 percent discount rate (rounded after-tax cost of debt) to analyze the refunding decision.
c. Calculate the net present value.
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