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Chapter 5: Q8DQ (page 524)

Under what circumstances would a call on a bond be exercised by a corporation? What is the purpose of a deferred call? (LO16-3)

Short Answer

Expert verified

A corporation exercises a call on a bond in case of repayment before the maturity date.

On the other hand, a deferred call ensures that bondholders will not surrender their securities before 5 to 10 years.

Step by step solution

01

Call on a bond

A call on a bond is one of the features of repayment of bonds that facilitates the corporation to retire the bonds before their due date.

02

Purpose of a deferred call

The corporations exercise call on a bond when interest rates on new securities are lower than the previously issueddebt.

The primary purpose of a deferred call is to ensure that bondholders will not ask for the retirement of their dues for at least initial 5 or 10 years.

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Most popular questions from this chapter

The Presley Corporation is about to go public. It currently has after-tax earnings of \(7,200,000, and 2,100,000 shares are owned by the present stockholders (the Presley family). The new public issue will represent 800,000 new shares. The new shares will be priced to the public at \)25 per share, with a 5 percent spread on the offering price. There will also be $260,000 in out-of-pocket costs to the corporation.

c. Compute the earnings per share immediately after the stock issue.

Explain how the bond refunding problem is similar to a capital budgeting decision. (LO16-3)

Trump Card Co. will issue stock at a retail (public) price of \(32. The company will receive \)29.20 per share.

a. What is the spread on the issue in the percentage terms?

b. If the firm demands receiving a new price only $2.20 below the public price suggested in part a, what will the spread be in percentage terms?

c. To hold the spread down to 2.5 percent based on the public price in part a, what net amount should Trump Card Co. receive?

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.

a. Calculate the present value of total outflows.
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