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Warren Industries: Proceeds of Bond Sale, Cash Flows, IRR, and Approximation Formula

Currently, Warren Industries can sell 15 year, $1000-par value bonds paying annual interest at a 12% coupon rate. As a result of current interest rates, the bonds can be sold for $1,010 each: flotation costs of $30 per bond will be incurred in this process. The firm is in the 40% tax bracket.

a) Find the net proceeds from sale of the bond Nd.

b) Show the cash flows from the firm's point of view over the maturity of the bond.

c) Use the IRR approach to calculate the before-tax and after-tax costs of debt.

d) use the approximation formula to estimate the before-tax and after-tax costs of debt.

e) compare and contrast the costs of debt calulated in parts c and d. Which approach do you prefer? Why?

Solution Preview

Please see the attached file.

Currently, Warren Industries can sell 15 year, $1000-par value bonds paying annual interest at a 12% coupon rate. As a result, of current interest rates, the bonds can be sold for $1,010 each: flotation costs of $30 per bond will be incurred in this process. The firl is in the 40% tax bracket.

a) find the net proceeds from sale of the bond Nd.

a. Net Proceeds Nd = Face Value + Premium - Flotation cost
Nd = 1,000+10-30 = $980

b) show the cash flows from the firm's point of view over the maturity of the bond.

The cash flows will be the inflow ...

Solution Summary

The solution explains the calculation of cash proceeds from bond sale and how to calculate the cost of debt.

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