1. The Bowman Corporation has a $20 million bond obligation outstanding, which it is considering refunding. Though the bonds were initially issued at 12 percent, the interest rates on similar issues have declined to 10.5 percent. The bonds were originally issued for 20 years and have 15 years remaining. The new issue would be for 15 years. There is an 8 percent call premium on the old issue. The underwriting cost on the new $20,000,000 issue is $570,000, and the underwriting cost on the old issue was $400,000. The company is in a 35 percent tax bracket, and it will use a 7 percent discount rate (rounded after-tax cost of debt) to analyze the refunding decision.
Should the old issue be refunded with new debt?
2. Assume the following financial data for Noble Corporation and Barnes Enterprises:
Noble Corp. Barnes Corp.
Total earnings———————————————– $1,200,000 $3,600,000
Number of shares of stock outstanding————– – 600,000 2,400,000
Earnings per share—————————————— $2.00 $1.50
Price-earnings ratio (P/E)——————————— 24x 32x
Market price per share———————————— $48 $48
A. If all the shares of Noble Corporation are exchanged for those of Barnes Enterprises on a share-for-share basis, what will post merger earnings per share be for Barnes Enterprises? Use an approach similar to that in Table 20-3.
B. Explain why the earnings per share of Barnes Enterprises changed.
C. Can we necessarily assume that Barnes Enterprises is better off after the merger?
3. Howell Auto Parts is considering whether to borrow funds and purchase an asset or to lease the asset under an operating lease arrangement. If the company purchases the asset, the cost will be $10,000. It can borrow funds for four years at 12 percent interest. The firm will use the three-year MACRS depreciation category (with the associated four-year write off). Assume a tax rate of 35 percent.
The other alternative is to sign two operating leases, one with payments of $2,600 for the first two years, and the other with payments of $4,600 for the last two years. In your analysis, round all values to the nearest dollar.
A. Compute the after tax cost of the leases for the four years.
B. Compute the annual payment for the loan (round to the nearest dollar).
C. Compute the amortization schedule for the loan. (Disregard a small difference from a zero balance at the end of the loan—due to rounding.)
D. Determine the depreciation schedule (see Table 12-9).
E. Compute the after tax cost of the borrow –purchase alternative.
F. Compute the present value of the after tax cost of the two alternatives. Use a discount rate of 8 percent.
G. Which alternative should be selected, based on minimizing the present value of after tax costs?