Lorre, Inc., recently issued new securities to finance a new TV show. The project cost $14 million, and the company paid $725,000 in flotation costs. In addition, the equity issued had a flotation cost of 7 percent of the amount raised, whereas the debt issued had a flotation cost of 3 percent of the amount raised. If the company issued new securities in the same proportion as its target capital structure, what is the companys target debtequity ratio?
Lorre, Inc., recently issued new securities to finance a new TV show. The project cost $14 million, and the company paid $725,000 in flotation costs. In addition, the equity issued had a flotation cost of 7 percent of the amount raised, whereas the debt issued had a flotation cost of 3 percent of the amount raised. If the company issued new securities in the same proportion as its target capital structure, what is the companys target debtequity ratio?
Related questions
P14-19 Calculating Flotation Costs [L04]
| Southern Alliance Company needs to raise $28 million to start a new project and will raise the money by selling new bonds. The company will generate no internal equity for the foreseeable future. The company has a target capital structure of 70 percent common stock, 10 percent preferred stock, and 20 percent debt. Flotation costs for issuing new common stock are 9 percent, for new preferred stock, 6 percent, and for new debt, 5 percent. What is the true initial cost figure Southern should use when evaluating its project?(Do not round your intermediate calculations.) |
| $29,185,668 | |
| $30,212,000 | |
| $31,617,806 | |
| $26,133,333 | |
| $30,401,737 |
| 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 = | |||||||
