Long-Term Debt and Leasing Cases: Nintendo and Barclay Polymers

A. Nintendo Corporation issued $ 10 million of 3.375 % coupon bonds 10 years ago with a 30 year maturity. Each bond has a par value of $ 1,000, and they are callable at 104 % of par value. Flotation costs were 0.5 %, and the bonds were initially sold at par. However the interest rate is currently 6.175% for 20 year bonds, and NC is considering issuing a new 20 year bonds and retiring the old bond issue, because the cash generated by the new bonds will be necessary to pay off old bonds, there would be a 1.5 month period during which both the old and the new issue would be outstanding. Nintendo Corporation is in a 35% tax bracket. Flotation costs on the new issue would be 0.25% and the new bonds would be sold at par.

1. Determine the initial investment if NC issue new bonds to retire the old bonds. Assume that NC will have to issue enough bonds to cover both the principle and the call premium associated with retiring the old issue.
2. Determine the annual cost low savings if NC refunds the old bond issue.
3. Calculate the net present value of the bond refunding, should NC refund the old issue.

B. Barclay Polymers needs to acquire new extruding machine whose purchase price is $600,000. However, the firm could lease the extruder from primal leasing corporation for a 5 year period and make annual payments of $115,000 at the begging of the year. If the extruder is leased, then primal leasing corporation would pay all maintenance costs and Barclay would have the opportunity to purchase the asset of $130,000 at the beginning of year 5. If the extruder is purchased by Barclay, then it will be financed by a five year loan at the annual rate of 8.75 %. Barclay would use the MACRS depreciation method over a five year recovery period. It would purchase a service contract for $ 8,000 a year, and would keep the extruder after its recovery period. If the firm pursues the purchase alternative, then it would secure a maintenance contract at an expected cost of $ 3,000 annually. The firm is in a 35 % tax bracket.

1. Calculate the annual after tax cash out flow for the leasing alternative.
2. Determine the annual interest and principle payments for the purchase alternative.
3. Determine the annual depreciation deduction for the purchase alternative.
4. Calculate the net present value of both leasing and the purchase alternatives and which method should Barclay polymers use to obtain the extruder?