NARRBEGIN: Loose Cannon refunding
Loose Cannon Co.
Loose Cannon Co.is evaluating a new $75 million bond issue,the proceeds of which would be used to call and retire its outstanding $75 million bonds.Details on both bond issues are presented below.The firm is in the 35% tax bracket.
Old Bonds The old issue sold at par,with a coupon rate of 11 percent.It was issued five years ago with a twenty year maturity.The issue had $350,000 in flotation costs and carries a call price of $1150.
New Bonds The new issue are expected to sell at par with an 8.5 percent coupon rate and a 15 year maturity.Flotation costs are forecast to be $500,000.Interest payments will overlap for 2 months while the old bonds are retired.
-Refer to Loose Cannon Co.What is the initial investment required to refund the bonds?

Question

Quizplus · Accepted Answer

To calculate the initial investment required to refund the bonds, we need to find the total cost of the new bonds and subtract the cash inflow from calling the old bonds.

Cash inflow from calling the old bonds = $1,150 x 75,000 = $86,250,000

Total cost of the new bonds = $75,000,000 + $500,000 = $75,500,000

Therefore, the initial investment required to refund the bonds = $75,500,000 - $86,250,000 = -$10,750,000

Since this result is negative, it means that Loose Cannon Co. will have a cash inflow of $10,750,000 when it refunds the bonds, so the correct answer is B.

NARRBEGIN: Loose Cannon Refunding