The Bowman Corporation has $20 million bond obligation outstanding, which is con

Question

The Bowman Corporation has $20 million bond obligation outstanding, which is considering refunding. Though the bonds were issued at 12 percent, the interest rates on similar issues have declined to 10.5 percent. The bonds were originally issued for 20 years remaining. The new issue would be for 15 years. There is an 8 percent call premium on the old issue. The underwriting cost on the new $20,000,000 issue is $570,000 and the underwriting cost on the old iss was $400,000. The company is in a 35 percent tax bracket, and it will us a 7 percent discount rate to analyze the refunding decision. Should the old issue be refunded with new debt?

Explanation / Answer

1.payment of call premium= 20,000,000 x 8%= 1,600,000

=1,600,000 (1-0.35)=1,040,000

Underwriting cost on new issue

Amortization of cots =( 570,000 /15 )(0.35) =13,300-----tax saving per year

Actual expenditure

570,000

PV= 13300 X 9.108

121,136

NEW COST

448864

COST saving in lower interest rates

12% x20,000,000

2,400,000/year

10.5 % x20,000,000

2,100,000/year

saving

300000

After saving 300000 (1-0.35)

195,000 year

Actual expenditure

570,000

PV= 13300 X 9.108

121,136

NEW COST

448864

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