Question

The Wagner Corporation has a $20 million bond obligation outstanding, which it is considering refunding. Though the bonds were initially issued at 16 percent, the interest rates on similar issues have declined to 13.3 percent. The bonds were originally issued for 20 years and have 16 years remaining. The new issue would be for 16 years. There is a 9 percent call premium on the old issue. The underwriting cost on the new $20 million issue is $550,000, and the underwriting cost on the old issue was $400,000. The company is in a 40 percent tax bracket, and it will allow an overlap period of one month (1/12 of the year). Treasury bills currently yield 5 percent. (Do not round intermediate calculations. Enter the answers in whole dollars, not in millions. Round the final answers to nearest whole dollar.) a. Calculate the present value of total outflows. Total outflows $ b. Calculate the present value of total inflows. Total inflows $ c. Calculate the net present value. Net present value $ d. Should the old issue be refunded with new debt? Yes No

Answer 1

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

Present value of annual cash inflows = Annual cash inflows/(1+yield on Treasury bills)^{maturity of new issue}

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

a. Present value of total outflows is $1,612,000.

b. Present value of total inflows is $3,573,755.

c. net present value is $1,961,755.

d. Yes, the old issue should be refunded with new debt because net present value is positive.

formula for Present value of total inflows is: "=PV(0.05,16,-329750,0)"