Five years ago, the State of Oklahoma issued $2,000,000 of 7% coupon, 20-year se
ID: 2701433 • Letter: F
Question
Five years ago, the State of Oklahoma issued $2,000,000 of 7% coupon, 20-year semiannual payment, tax-exempt bonds. The bonds had 5 years of call protection, but now the state can call the bonds if it chooses to do so. The call premium would be 5% of the face amount. Today 15-year, 5%, semiannual payment bonds can be sold at par, but flotation costs on this issue would be 2%. What is the net present value of the refunding? Because these are tax-exempt bonds, taxes are not relevant.
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Explanation / Answer
call premium = 5% * 2000000 = 100000
floatation cost = 2% * 2000000 = 40000
total investment outlay = 140000
interest on old bond = 7%/2 * 2000000 = 70000
interest on new bond = 5%/2 * 2000000 = 50000
savings = 20000
PV of savings = 20000 * PVIFA(2.5%, 30) = 418606
NPV of refundings = PV of savings - cost of refunding
= 418606 - 140000 = 278606
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