Question

Refunding Analysis Mullet Technologies is considering whether or not to refund a $100 million, 14% coupon, 30-year bond issue that was sold 5 years ago. It is amortizing $3 million of flotation costs on the 14% bonds over the issue's 30-year life. Mullet's investment banks have indicated that the company could sell a new 25-year issue at an interest rate of 11% in today's market. Neither they nor Mullet's management anticipate that interest rates will fall below 11% any time soon, but there is a chance that rates will increase. A call premium of 9% would be required to retire the old bonds, and flotation costs on the new issue would amount to $7 million. Mullet's marginal federal-plus-state tax rate is 40%. The new bonds would be issued 1 month before the old bonds are called, with the proceeds being invested in short-term government securities returning 5% annually during the interim period. Conduct a complete bond refunding analysis. What is the bond refunding's NPV? Do not round intermediate calculations. Round your answer to the nearest cent.

Answer 1

NPV of refunding decision = Total cash outflow for refund - Present value of annual cash flows

Present value of annual cash flows = Annual cash flows/(1+return on short-term govt. securities)^{maturity of new issue}

Annual cash flows = Total amortization tax effects + Net after tax interest savings

Bond refunding's NPV is $14,533,864.23.