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Financial Management Week 7 Homework

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FI360 Financial Management

Chapter 13: Problems 13-1

P13-1. The initial proceeds per bond, the size of the issue, the initial maturity of the bond, and the years remaining to maturity are shown in the following table for a number of bonds. In each case the bond has a $1,000 par value, and the issuing firm is in the 40% tax bracket.
a. Indicate whether each bond was sold at a discount, at a premium, or at its par value.

b. Determine the total discount or premium for each issue.

c. Determine the annual amount of discount or premium amortized for each bond.

d. Calculate the unamortized discount or premium for each bond.

e. Determine the after-tax cash flow associated with the retirement now of each of these bonds, using the values developed in part (d).

Premium/discount per bond = Proceeds per bond – Par value per bond
Total Premium/discount = Premium/Discount per bond ´ Size of issue (# of bonds)
Annual premium/discount amortized per bond = Prem/Disc per bond ¸ Initial maturity (in years)
[Premiums added to earnings each year, so increase taxable income and taxes paid;
Discounts deducted from earnings each year, so reduce taxable income and taxes paid]
Unamortized premium/discount per bond = Annual prem/Disc per bond ´ Number years remaining
After-tax cash flow = [– (Unamortized prem/Disc per bond ´ Size of issue ´ Corporate tax rate)]
[Retiring premium bonds: remaining premium realized as income, increasing taxes payable;
Retiring discount bonds: remaining discount deducted from income, reducing taxes payable] Bond Premium (+) or Discount (–) per Bond Total
Premium or Discount per Bond Annual
Premium or Discount per Bond Unamortized Premium or Discount per Bond After-Tax
Cash Flows from Retiring Issue
A –$15.00 –$150,000 –$0.75 –$11.25 +$45,000
B +25.00 +500,000 +1.00 +16.00 –128,000
C 0 0 0 0 0
D –40.00 –200,000

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