You are considering refunding a $15,000,000 twelve year bond with a 10% annual coupon and replacing it with a $15,000,000 twelve year bond with a 7% annual coupon. Your tax rate is 40%, what would be the present value of the after tax savings? (discounted at an appropriate rate)

Question

Quizplus · Accepted Answer

The present value of the after-tax savings from refunding can be calculated by finding the difference in the annual interest payments of the two bonds, adjusting for taxes, and then discounting these savings back to their present value. The original bond has an annual interest payment of $1,500,000 (10% of $15,000,000), and the new bond has an annual interest payment of $1,050,000 (7% of $15,000,000). The annual savings before taxes would be $450,000 ($1,500,000 - $1,050,000). After adjusting for a 40% tax rate, the after-tax savings per year would be $270,000 ($450,000 * (1 - 0.40)). To find the present value of these savings over 12 years, we discount them at the new interest rate (7%). The present value of an annuity formula is used here, resulting in the correct answer being $2,504,817.

You Are Considering Refunding a $15,000,000 Twelve Year Bond with a 10