Question

The Rebellion issued $50,000,000 face value of 30-year bonds carrying a 12% (annual payment) coupon; these bonds were issued five (5) years ago. The Rebellion would now like to refund these bonds that were issued five years ago. These bonds have been amortizing $1.5 million of flotation costs over their 30-year life. The Rebellion could sell a new issue of 25-year bonds at an annual interest rate of 10.00% in today's market. A call premium of 12% would be required to retire the old bonds, and flotation costs on the new issue would amount to $1.5 million. The Rebellion’s marginal tax rate is 30%. The new bonds would be issued when the old bonds are called. What is The Rebellion’s necessary after-tax refunding investment expenditure, (i.e., the cash amount at the time of the refunding)?

The Rebellion issued $50,000,000 face value of 30-year bonds carrying a 12% (annual payment) coupon; these bonds were issued five (5) years ago. The Rebellion would now like to refund these bonds that were issued five years ago. These bonds have been amortizing $1.5 million of flotation costs over their 30-year life. The Rebellion could sell a new issue of 25-year bonds at an annual interest rate of 10.00% in today's market. A call premium of 12% would be required to retire the old bonds, and flotation costs on the new issue would amount to $1.5 million. The Rebellion’s marginal tax rate is 30%. The new bonds would be issued when the old bonds are called.

The Rebellion issued $50,000,000 face value of 30-year bonds carrying a 12% (annual payment) coupon; these bonds were issued five (5) years ago. The Rebellion would now like to refund these bonds that were issued five years ago. These bonds have been amortizing $1.5 million of flotation costs over their 30-year life. The Rebellion could sell a new issue of 25-year bonds at an annual interest rate of 10.00% in today's market. A call premium of 12% would be required to retire the old bonds, and flotation costs on the new issue would amount to $1.5 million. The Rebellion’s marginal tax rate is 30%. The new bonds would be issued when the old bonds are called.

The Rebellion’s amortization of the flotation costs reduces The Rebellion’s taxes, which provides an annual cash flow. What will The Rebellion’s net increase or decrease in the annual flotation cost tax savings be if The Rebellion refunds the bonds?

The Rebellion issued $50,000,000 face value of 30-year bonds carrying a 12% (annual payment) coupon; these bonds were issued five (5) years ago. The Rebellion would now like to refund these bonds that were issued five years ago. These bonds have been amortizing $1.5 million of flotation costs over their 30-year life. The Rebellion could sell a new issue of 25-year bonds at an annual interest rate of 10.00% in today's market. A call premium of 12% would be required to retire the old bonds, and flotation costs on the new issue would amount to $1.5 million. The Rebellion’s marginal tax rate is 30%. The new bonds would be issued when the old bonds are called.

If the Rebellion were to refund the bonds today, what would the NPV be?

Answer 1

NPV of Bond Refunding Decision

Step 1 : Calculation of Initial Investment (Y) or After Tax Refunding investment expenditure

PARTICULARS	AMOUNT $
Refund of Old Bonds ($50000000+12%)	60000000
Less : Net Proceeds From New Bond Issue ($5000000-1500000)	(48500000)
Less : Tax Shield on Call Premium ( 30% OF 10000000)	(3000000)
Less : Tax shield on Unamortized Flotation Cost    (	(375000)
Initial Investment	8125000

Step 2 : Calculation of Annual Post Tax Savings (X)

Particulars	Old Bond	New Bond
Post Tax Coupon Amount 12%*50000000*0.7 10%*50000000*0.7	4200000	3500000
Less : Annual Tax Shield On Flotation Cost             (1500000/30)*0.30             (1500000/25) * 0.30	(15000)	(18000)
Annual Post Tax Savings	4185000	3482000

Therefore Annual Savings Post Tax (X) = 4185000-3482000 = $703000

Step 3 : NPV

Important Assumption : The firms Cost of Debt is not Provided in the Question to calculate NPV we have assumed that the ms cost of debt is 7 % (10*0.70) i.e after tax cost of new debentures. If different cost of debt is given student shall replace cost of debfirt in step 3.

NPV = X * PVAF (7%,25) – Y

        = ($703000*11.653) - $ 8125000

         = $ 8192059 - $ 8125000

         = $ -67059

Since NPV is Negative bond Refunding Decision is not Viable