Suppose your company needs to raise $53 million and you want to issue 20-year bonds for this purpose. Assume the required return on your bond issue will be 5.3 percent, and you’re evaluating two issue alternatives: a semiannual coupon bond with a coupon rate of 5.3 percent, and a zero coupon bond. Your company’s tax rate is 21 percent. Both bonds will have a par value of $1,000. a-1. How many of the coupon bonds would you need to issue to raise the $53 million? a-2. How many of the zeroes would you need to issue? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) b-1. In 20 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, 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, e.g., 1,234,567.) c. Calculate the aftertax cash flows for the first year for each bond. (Do not round intermediate calculations and enter your answers in dollars, not millions of dollars, e.g., 1,234,567. Enter your answers as positive numbers.)

a-1) The number of the coupon bonds that your company would need to issue to raise the $53 million is 53,000 bonds ($53,000,000/$1,000).

a-2) The number of the zero-coupon bonds that your company would need to issue to raise the $53 million is 148,882 bonds ($53,000,000/$18,867,243.13 x 53,000).

b-1) In 20 years, your company's repayment will be $109,180,000 ($53,000,000 + $1,404,500 x 40) if it issues the coupon bonds.

b-2) In 20 years, your company's repayment will be $53,000,000 if it issues the zero bonds.

c) The calculation of the after-tax cash flows for the first year of each bond is as follows:

Coupon Bonds Zero Coupon Bonds

Interest Expense $2,809,000 $0

After-tax cash flows $2,809,000 ($589,890) ($2,809,000 x 21%)

What is the difference between a coupon bond and a zero-coupon bond?

A coupon bond earns periodic interest at the coupon-stated rate while a zero-coupon bond does not earn periodic interest.

A zero-coupon bond is usually deeply discounted at issuance. This implies that it is issued at less than the face value. For both, the amount to be repaid at maturity remains the face values of the bonds.

Data and Calculations:

Face value of bonds = $53 million

Maturity period = 20 years

Coupon interest rate = 5.3%

Interest payment = semiannual

Corporate tax rate = 21%

Par value of both bonds = $1,000

Price of coupon bonds = $53,000,000

Price of zero-coupon bonds = $18,867,243.13

N (# of periods) = 20 years

I/Y (Interest per year) = 5.3%

PMT (Periodic Payment) = $0

FV (Future Value) = $53,000,000

Results:

PV = $18,867,243.13

Total Interest $34,132,756.87

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