Five years ago, NWA issued $50,000,000 face value of 30-year bonds carrying a 14

Question

Five years ago, NWA issued $50,000,000 face value of 30-year bonds carrying a 14% annual payment coupon. NWA is now considering refunding these bonds. It has been amortizing $3 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 11.67% in today's market. A call premium of 14% would be required to retire the old bonds, and flotation costs on the new issue would amount to $3 million. NWA's marginal tax rate is 40%. The new bonds would be issued when the old bonds are called (no overlapping interest). Should the firm refund the bonds? Why? Show all steps and formulas.

Explanation / Answer

Existing rate of Bond 14% Coupon rate of new bond 11.67% %age of savings 2.33% Bond Value           50,000,000.00 Net Interest Saving           29,125,000.00 Less: Call Premium payable for new issue           (7,000,000.00) Less: Flotation cost of new bond           (3,000,000.00) Less: unamortized Flotation cost of old bond (3,000,000-5*100,000)           (2,500,000.00) Net Gain           16,625,000.00 New issue could save net interest of $16,625,000 Hence, firm should refund the bond.

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