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 are the annual cash flows associated with the new bonds?

Question

Quizplus · Accepted Answer

To calculate the annual cash flows associated with the new bonds, we need to use the following formula:

Annual cash flow = Coupon payment - Flotation cost + (Call price - Par value) / Number of years to maturity

Coupon payment = Par value x Coupon rate = $1,000 x 8.5% = $85
Flotation cost = $500,000
Number of years to maturity = 15
Par value = $1,000

So, the annual cash flow for the new bonds can be calculated as:

Annual cash flow = $85 - $500,000 / 15 + ($1,150 - $1,000) / 15 = $4,132,083

Therefore, the best choice is C.

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