CLASS / COURSE: Finance
One year ago Fox Inc., issued $100 million of 11-year bonds with a 9% coupon, payable annually. The first coupon payment has just been paid. The bonds are callable at 103 beginning today. Floatation costs on that issue were $1 million. Fox has a 34% marginal tax rate.
Since interest rates have fallen, Fox is considering calling in the bonds and refinancing at current rates. It has two, ten-year, financing alternatives.
1) A $100 million public issue of 8% annual coupon bonds. Flotation costs would be $1 million.
2) An 8%, $100 million private placement with semi-annual coupons. There would be a front-end replacement fee of $250,000.
Note: Call premiums and interest payments are tax deductible. However, front-end fees and flotation costs must be capitalized and amortized over the life of the bond.
a. Calculate the effective cost of raising funds from the public bond issue. Use the IRR procedure for all your calculations.
b. Calculate the effective cost of raising funds from the private placement of debt.
c. If Fox does call in the bonds, which of the two refinancing alternatives is preferable?
d. What is the effective, after-tax of leaving the existing bonds in place? In other words, what would be the after-tax all-in cost of refinancing that would make Fox indifferent between calling the bonds and leaving them in place?
e. Should Fox call in the bonds?
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SUBJECTS / CATEGORIES:
2. Financial Management
3. Corporate Finance
4. Business and Finance Case Studies