Question -
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.
Bond Proceeds Size Initial Maturity Years Remaining
Per Bond of Issue of Bond to Maturity
A $ 985 10,000 20 Years 15 Years
B 1,025 20,000 25 16
C 1,000 22,000 12 9
D 960 5,000 25 15
E 1,035 10,000 30 16
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.
2. Eastern Trucking Company needs to expand its facilities. In order to do so, the firm must acquire a machine costing $800,000. The machine can be leased or purchased. The firm is in the 40% tax bracket, and its after tax cost of debt is 5.4%. The terms of the lease and purchase plans are as follow:
Lease: The leasing arrangement requires beginning of year payments of $16,900 over five years. The lessee will exercise its option to purchase the asset for $20,000, to be paid along with the final lease payment.
Purchase: if the firm purchases the machine, its cost of $80,000 will be financed with a five year, 9% loan (pre-tax) requiring equal end of year payments of $20,567. The machine will be depreciated on a straight line basis for five years. The firm plans to keep the equipment and use it beyond its five year recovery period.
a. Determine the after tax cash outflows of Eastern Trucking under each alternative.
b. Find the present value of the after tax cash outflows for each alternative using the after tax cost of debt.
c. Which alternative lease or purchase would you recommend? Why?