Question

Daedulus Wings has had several successful years in the airline business and had

received recognition from many quarters for flying higher, further and cheaper than

the competition. Its financial state of affairs has not been as successful. The new

vice-president of finance is reviewing some debentures that carry fairly high

semiannual payments.

The vice president notes in particular a bond issue that was issued 8 years ago with

15 years to maturity at an annual rate of 12 percent, payable semiannually. It has a

call provision at a premium of 8 percent above par value. The bond issue has $50

million outstanding.

Current long-term interest rates are 7.5 percent, payable on a semiannual basis and

short-term rates are 3 percent. If the old bonds are called the vice-president will

require a 15-day overlap period. Wings has a tax rate of 35 percent. Underwriting

and other financing expenses will be $1 million.

Should the old issue be refunded and replaced with a debt issue with a comparable

maturity? Show all calculations.

Answer 1

the old issue should be refunded and replaced with a debt issue with a comparable maturity because NPV of refunding and replacing old issue is positive $6,851,536.