Problem 17
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The Bowman Corporation has a $20 million bond obligation outstanding, which it is considering refunding. |
| Though the bonds were initially issued at 12 percent, the interest rates on similar issues have declined |
| to 10.5 percent. The bonds were originally issued for 20 years and have 15 years remaining. The new issue |
| would be for 15 years. There is an 8 percent call premium on the old issue. The underwriting cost on the |
| new $20 million issue is $570,000, and the underwriting cost on the old issue was $400,000. The company is |
| in a 35 percent tax bracket, and it will use a 7 percent discount rate (rounded after-tax cost of debt) |
| to analyze the refunding decision. |
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Should the old issue be refunded with new debt?
Problem 20 B
Howell Auto Parts is considering whether to borrow funds and purchase an asset or to lease the asset under an operating lease arrangement.If the company purchases the asset, the cost will be $10,000. It can borrow funds for four years at 12%. The firm will use the three year MACRS depreciation category(with the associated 4-year write off). Assume a tax rate of 35%a. Compute the aftertax cost of the lease for 4 years.b. Compute the annual payment for the loan.c.Compute the amortization schedule for the loan.d. Determine the depreciation schedule.e. Compute the after tax cost of borrow-purchase alternative.f.Compute the present value of the aftertax cost of the two alternatives. Use a discount rate of 8%g.Which alternative should be selected, based on miimizing the present value of aftertax costs?
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