Refunding Analysis Mullet Technologies is considering whether or not to refund a

Question

Refunding Analysis

Mullet Technologies is considering whether or not to refund a $175 million, 13% coupon, 30-year bond issue that was sold 5 years ago. It is amortizing $8 million of flotation costs on the 13% 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 9% in today's market. Neither they nor Mullet's management anticipate that interest rates will fall below 9% any time soon, but there is a chance that rates will increase.

A call premium of 11% would be required to retire the old bonds, and flotation costs on the new issue would amount to $3 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 4% annually during the interim period.

Conduct a complete bond refunding analysis. What is the bond refunding's NPV? Round your answer to the nearest cent.

Explanation / Answer

since Cost of capital is not given , we will take 9 %(1-.40) as a cost of debt

                                                                   = 5.4 %

Initial outflow=

Old bonds-retire= 175

Premium on old bond (net of tax shield) = [19.25-(19.25*40)%] =                     11.55

Tax shield on floatation cost on old bonds [8/30*25 =6.667*40%]                       ( 2.667)

Interest on old bonds for 1 month [(175*13%*1/12= (1.8958 * 1.8958*40%)]         1.1375

New bond                                                                                                        (175)

Floatation cost                                                                                                 3

INterest earned for 1 month [175*4%*1/12] =(.5833 - .5833*40%)                      ( .35)

Intial outflow =    12.6705

Now, Interest Savings = 13%- 9% = 4%

Interest savings net of tax sheild =4% of 175 =7

=7 -7*40%   = $ 4.20 (savings)

Tax shield on floatation cost every year = Floatation cost on old bonds -new bonds)
                                        = 8/30   -   3/25

                                       =.1467

Tax shield =.1467 *40%

                = .0587 (loss)

Net benefit every year =4.1413

PVAF=5.4%,25years = 13.5458

present value of Net benefit= 13.5458*4.1413

                                            = $56.0972

NPV= 56.0972 - 12.6705

        = $43.4267

Approx $ 43

So new bonds should be issued as NPV is positive.

Related Questions

Navigate

• Browse (All)
• Browse R
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.