Problem 3

Problem 7
Input Data

Investment Outlay

Annual Flotation Cost Tax Effects

Annual Interest Savings Due to Refunding

 Chapter 18

Business Value
Total Current Shares
Price/Share
Investment of 200000 @ $20/share
Angel Investment
Shares Sold to Investor

Input Data
Existing bond issue
Original Floatation cost
Maturity of original debt
Years since old debt issue
Call premium (%)
Original coupon rate
After-tax cost of new debt

Investment Outlay
After Tax Call Premium on old Bond [ Old Face Value Call Premium % (1-t)]
Flotation costs on new issue
Immediate tax savings on old flotation cost expense [Old Flotation New Maturity/Old Maturity ]t
Extra interest paid on old issue [ Old Face Valueold CR%(OLP/12)(1-t)]
Interest earned on short-term investment [Face ValueShort term i%OLP/12](1-t)
Total after-tax investment

Annual Flotation Cost Tax Effects

Annual Tax Saving from new issue flotation cost [New FC/New maturity]t
Annual Tax Saving from old issue flotation cost [Old FC/Old maturity]t
Net Savings (A)

Annual Interest Savings Due to Refunding

After tax Interest on old bond [FvnewCR%](1-t)
After tax Interest on new bond [FV old CR%)(1-t)
Net interest savings(B)

Annual Cash Flows (A+B)

After Tax Interest Rate
PV of Annual Cash flows [Annual CFsPVIFA@k% for n years]
NPV of Refund [PV of Cash Flows - Net Investment Outlay}
$ 800,000
40000
$ 20.00

$ 200,000
10,000

Problem 7
Mullet Technologies is considering whether or not to refun
million, 12% coupon, 30-year bond issue that was sold 5 ye
$ 75,000,000 New bond issue $ 75,000,000 amortizing $5 million of floatation costs on the 12% bonds
issue's 30-year life. Mullet's investment banks have indicat
$ 5,000,000 New floatation cost $ 5,000,000 company could sell a new 25-year issue at an interest rate o
30 New bond maturity 25 today's market. Neither they nor mullet's management anti
interest rates will fall below 10% any time soon, but there i
5 New cost of debt 10% that rates will increase.
12%
A call premium of 12% would be required to retire the old b
12% Tax rate 40% flotation costs on the new issue would amount to $5 millio
Short-term interest rate 6% marginal federal-plus-state tax rate is 40%. The new bonds
issued 1 month before the old bonds are called, with the p
invested in short-term government securities returning 6%
Before-Tax After-Tax during the interim period.
$ (9,000,000) $ (5,400,000) Conduct a complete bond refunding analysis. What is the
(5,000,000.00) (5,000,000.00) refunding's NPV?
4,166,666.67 1,666,666.67
(450,000.00) (450,000.00)
225,000.00 225,000.00
$ (10,058,333) $ (8,958,333)

Before-Tax After-Tax
$ 200,000 $ 80,000
(166,666.67) (66,666.67)
$ 33,333 $ 13,333

Before-Tax After-Tax
$ 9,000,000 $ 5,400,000
(7,500,000.00) (4,500,000.00)
$ 1,500,000 $ 900,000

Before-Tax After-Tax
$ 1,533,333 $ 913,333
0.06

$2,717,131.96
 sidering whether or not to refund a $75
ear bond issue that was sold 5 years ago. It is
oatation costs on the 12% bonds over the
's investment banks have indicated that the
25-year issue at an interest rate of 10% in
ey nor mullet's management anticipated that
w 10% any time soon, but there is a chance

uld be required to retire the old bonds, and

issue would amount to $5 million. Mullet's
e tax rate is 40%. The new bonds would be
old bonds are called, with the proceeds being
ernment securities returning 6% annually

refunding analysis. What is the bond

 Chapter 19

Problem 4
Problem Variables
NAL=PV Cost of Owning - PV Cost of Leasing
Tax Rate 40%
Loan Interest Rate 15%
Install Costs 1,500,000
Loan Value 1,500,000
After-tax Interest Rate(Loan) 9%
Residual Value 250,000
Lease Payments (400,000)

Year 3-Year Deprec.

1 0.3333 $ 499,950
2 0.4445 $ 666,750
3 0.1481 $ 222,150
4 0.0741 $ 111,150

Payment ($463,002.99)

PV Cost of Owning: 1 2
After-Tax Loan Payments ($463,002.99) ($463,002.99)
Deprec. Tax Savings 199,980 266,700
Residual Value
Tax on Residual Value
Net Cash Flow $ (263,021.99) $ (196,300.99)
($241,304.58) ($165,222.62)
PV Cost of Owning: ($885,671.71)

PV Cost of Leasing: 1 2
Lease Payment (400,000) (400,000)
Tax Savings 160,000 160,000
Net Cash Flow (240,000) (240,000)
($220,183.49) ($202,003.20)
PV Cost of Owning: ($777,532.77)

Net Advantage Lease (NAL)

NAL=PV Cost of Owning - PV Cost of Leasing ($108,138.94)
 MACRS 3-Year Class
Problem 4
Year 3-Year Big Sky Mining Company must install $1.5 Million of
1 0.3333 new machinery in its Nevada mine. It can obtain a bank
2 0.4445 loan for 100% of the purchase price, or it can lease the
machinery. Assume that the following facts apply.
3 0.1481
4 0.0741 1-Machinery falls into MARCS 3-year class
2-Under either lease or purchase, Big Sky must pay for
insurance, property taxes, and maintenance
3-Firm's Tax rate is 40%
4-Loan would have an interest rate of 15%. It would be
nonamortizing, with only interest paid at the end of
each year for 4 years and the principal repaid at year 4.
5-Lease trms call for $400000 payments at the end of
Deprec Tax Savings each of the next 4 years.
6-Big Sky Mining has no use for machine beyond
$ 199,980 expiration of lease and the machine has a a residual
$ 266,700 value of $250,000 at end of year 4.
$ 88,860
What is the NAL of the lease?
$ 44,460

3 4
($463,002.99) ($463,002.99)
88,860 44,460
250,000
(100,000)
$ (374,139.99) $ (268,538.99)
($288,904.72) ($190,239.79)

3 4
(400,000) (400,000)
160,000 160,000
(240,000) (240,000)
($185,324.04) ($170,022.05)
 Chapter 19 Home Work - Handout Problem 6

Machine Cost -100000 MACRS 3-Year Class

Year 3-Year Deprec.
MACRS 3-year 1 0.3333 33330
3 year life 2 0.4445 44450
Residual value after 3 years 30000 3 0.1481 14810
After-tax Interest Rate(Loan) 0.08 4 0.0741 7410

Lease
Carmichael Cleaners needs
3 year lease -29000 Beginning machine that costs $100,0
Lease Includes Maintenance evaluating whether it shou
machine. The equipment f
year class, and it would be
Tax 20% then sold, because the firm
facility at that time. The es
Purchase equipment after 3 years is
contract the equipment wo
3 year loan payable at the beginning o
Interest paid at EOY the Firm could lease the eq
Before-Tax Cost 10% lease payment of $29000 p
beginning of each year. The
Repaid A EO3Y -100000 End maintenance. The firm is in
Yearly Maintenance -3000 Beginning and it could obtain a 3-yea
interest payable at the end
the equipment at a before
$100,000 should be repaid
Year 0 1 2 3 year. If there is a positive N
the firm will lease the equi
Lease buy it. What is the NAL? (
Cash Out Flow -29000 -29000 -29000 rate for Year 1 to 4 are 0.33
Tax Savings 5800 5800 5800 0741.)
Net Cash Flow -23200 -23200 -23200
-23200 -21481.5 -19890.3
PV of Cost of Lease -64571.7

Purchase
Maintenance -3000 -3000 -3000
Loan Interest -10000 -10000 -10000
Repayment -100000
Tax Interest Savings 2000 2000 2000
Deprec Tax Savings 6666 8890 2962
Maint. Tax Savings 600 600 600
Residual Value 24000
Net Cash Flow -2400 -3734 -1510 -81038
-2400 -3457.41 -1294.58 -64330.6
PV of Cost Purchase -71482.6

Net Advantage Lease (NAL)

NAL=PV Cost of Owning - PV Cost of Leasing -6910.82
 armichael Cleaners needs a new stream finishing
machine that costs $100,000. The company is
valuating whether it should lease or purchase the
machine. The equipment falls into the MACRS 3-
ear class, and it would be used for 3 years and
hen sold, because the firm plans to move to a new
acility at that time. The estimated value of the
quipment after 3 years is $30,000. A maintenance
ontract the equipment would cost $3000 per year,
ayable at the beginning of each year. Alternatively,
he Firm could lease the equipment for 3 years for a
ease payment of $29000 per year, payable at the
eginning of each year. The lease would include
maintenance. The firm is in the 20% tax bracket,
nd it could obtain a 3-year simple interest loan,
nterest payable at the end of the year, to purchase
he equipment at a before-tax cost of 10%; the
100,000 should be repaid at the end of the third
ear. If there is a positive Net Advantage to Leasing
he firm will lease the equipment. Otherwise, it will
uy it. What is the NAL? (Note: Assume MACRS
ate for Year 1 to 4 are 0.3333, .4445, .1481, and .
741.)