Five years ago, Northwest Water (NWW) issued $40,000,000 face value of 30-year b
ID: 2640886 • Letter: F
Question
Five years ago, Northwest Water (NWW) issued $40,000,000 face value of 30-year bonds carrying a 8% (annual payment) coupon. NWW is now considering refunding these bonds. It has been amortizing $4 million of flotation costs on these bonds over their 30-year life. The company could sell a new issue of 25-year bonds at an annual interest rate of 6% in today's market. A call premium of 5% would be required to retire the old bonds, and flotation costs on the new issue would amount to $3 million. NWW's marginal tax rate is 40%. The new bonds would be issued when the old bonds are called
a. The amortization of flotation costs reduces taxes and thus provides an annual cash flow. what will the net increase or decrease in the annual flotation cost tax savings be if refunding takes place?
Explanation / Answer
a. Annual Flotation Cost amortization on Old Bonds: 4,000,000 / 30= $133,333.33
Annual Flotation Cost Amortization on new Bonds: 3,000,000 / 25 = $120,000
Tax Saving on Old Bonds: 133,333.33 x 40% = $53,333.33
Tax Saving on New Bonds: 120,000 x 40% = $48,000
Net Decrease in Annual Flotation Cost Tax Saving: $5,333.33
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