Question

Suppose your company needs to raise $39 million and you want to issue 30-year bonds for this purpose. Assume the required return on your bond issue will be 7 percent and you’re evaluating two issue alternatives: A semiannual coupon bond with a coupon rate of 7 percent and a zero coupon bond. Your company’s tax rate is 24 percent. Assume a par value of $1,000.

a-1.	How many of the coupon bonds would you need to issue to raise the $39 million? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)

a-2.	How many of the zeroes would you need to issue? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)

b-1.	In 30 years, what will your company’s repayment be if you issue the coupon bonds? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to the nearest whole number, e.g., 1,234,567.)

b-2.	What if you issue the zeroes? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to the nearest whole number, e.g., 1,234,567.)
c.	Calculate the firm’s aftertax cash outflows for the first year for each bond. (Enter your answers as positive values. Do not round intermediate calculations and enter your answers in dollars, not millions of dollars, rounded to the nearest whole number, e.g., 1,234,567.)

Answer 1

a-1

The coupon bonds have a 7 percent coupon which matches the 7 percent required return, so they will sell at par. The number of bonds that must be sold is the amount needed divided by the bond price, so:

Number of coupon bonds to sell = $39,000,000 / $1,000 = 39,000

a-2

The number of zero coupon bonds to sell would be:

Price of zero coupon bonds = $1,000/1.07³⁰= $131.37

Number of zero coupon bonds to sell = $39,000,000 / $131.37 = 296,878

b-1

The repayment of the coupon bond will be the par value plus the last coupon payment times the number of bonds issued. So: Coupon bonds repayment

= 39,000 ($1,070) = $41,730,000

b-2

The repayment of the zero coupon bond will be the par value times the number of bonds issued, so:

Zeroes: repayment = 296,878 ($1,000) = $296,878,000