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2.6 (6 points) Recently, Midrand Hospitals Inc. filed for bankruptcy. The firm was reorganized as American Hospitals Inc., and the court permitted a new indenture on an outstanding bond issue to be put into effect. The issue has 10 years to maturity and a coupon rate of 10 percent, paid annually. The new agreement allows the firm to pay no interest for 5 years. Then, interest payments will be resumed for the next 5 years. Finally, at maturity (Year 10), the principal plus the interest that was not paid during the first 5 years will be paid. However, no interest will be paid on the deferred interest. If the required annual return is 20 percent, what should the bonds sell for in the market today?

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Recently, Ohio Hospitals Inc. filed for bankruptcy. The firm was reorganized as American Hospitals Inc., and the court permitted a new indenture on an outstanding bond issue to be put into effect. The issue has 10 years to maturity and a coupon rate of 10 percent, paid annually. The new agreement allows the firm to pay no interest for 5 years. Then, interest payments will be resumed for the next 5 years. Finally, at maturity (Year 10), the principal plus the interest that was not paid during the first 5 years will be paid. However, no interest will be paid on the deferred interest. If the required annual return is 20 percent, what should the bonds sell for in the market today?

Consider a corporation who recently filed Chapter 11 bankruptcy (reorganization). Under the reorganization, the company has been allowed to reorganize their debt structure with a consolidated new bond issue with more favorable terms.

The new issue will be a 30-year, 9% coupon rate bond with semiannual coupons. However, under the new indenture, the company is relieved of making interest payments for the first 10 years. For the remaining 20 years, the regular interest payments would resume. The indenture calls for the deferred interest to be paid in two equal installments: one at the end of year 20, and one at maturity. Each bond has a $1,000 par value.

Assuming a yield to maturity of 7%, the value of a new $1,000 par value bond is closest to:

A $609.88.
B $780.66.
C $1,213.55.
D $1,384.33.

Schumann Shoe Manufacturer is considering whether or not to refund a $70 million, 10% coupon, 30-year bond issue that was sold 8 years ago. It is amortizing $4.5 million of flotation costs on the 10% bonds over the issue's 30-year life. Schumann's investment bankers have indicated that the company could sell a new 22-year issue at an interest rate of 8 percent in today's market. Neither they nor Schumann's management anticipate that interest rates will fall below 6 percent any time soon, but there is a chance that interest rates will increase.
A call premium of 10 percent would be required to retire the old bonds, and flotation costs on the new issue would amount to $5 million. Schumann's marginal federal-plus-state tax rate is 40 percent. The new bonds would be issued 1 month before the old bonds are called, with the proceeds being invested in short-term government securities returning 5 percent annually during the interim period.
Current bond issue data
Par value $ 70,000,000
Coupon rate 10%
Original maturity 30
Remaining maturity 22
Original flotation costs $ 4,500,000
Call premium 10%
Tax rate 40%
Refunding data
Coupon rate 8.0000%
Maturity 22
Flotation costs $ 5,000,000
Time between issuing new bonds and calling old bonds (months) 1
Rate earned on proceeds of new bonds before calling old bonds (annual) 5%
a. Perform a complete bond refunding analysis. What is the bond refunding's NPV?
Initial investment outlay to refund old issue:
Call premium on old issue =
After-tax call premium =
New flotation cost =
Old flotation costs already expensed =
Remaining flotation costs to expense =
Tax savings from old flotation costs = You get to expense the remaining flotation costs
Additional interest on old issue after tax = This is interest paid on the old bond issue between when the new bonds are issued and the old bonds are retired
Interest earned on investment in T-bonds after tax = This is interest earned on the proceeds from the new bonds before they are used to pay off the old bonds.
Total investment outlay =
Annual Flotation Cost Tax Effects:
Annual tax savings on new flotation =
Tax savings lost on old flotation =
Total amortization tax effects =
Annual interest savings due to refunding:
Annual after tax interest on old bond =
Annual after tax interest on new bond =
Net after tax interest savings =
Annual cash flows =
After-tax cost of new debt =
NPV of refunding decision =
b. At what interest rate on the new debt is the NPV of the refunding no longer positive?
Use Goal Seek to set cell D60 to zero by changing cell C27.
"Break-even" interest rate =

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