Five years ago, the State of Rhode Island issued $2,000,000 of 7% coupon, 20-yea

Question

Five years ago, the State of Rhode Island 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%. a) What is the net present value of the refunding? Because these are tax-exempt bonds, taxes are not relevant. The company's decision of whether to call the bonds depends critically on the current interest rate on newly issued bonds. b) What is the breakeven interest rate, the rate below which it would be profitable to call in the bonds?

Explanation / Answer

Bond Refunding Analysis Current bond issue information Par value $         20,00,000 coupon rate 7% original maturity 20 remaining maturity                           15 original flotation costs $                        -   Call premium 5% Tax rate 0% New issue information Coupon rate 5.0000% maturity                           15 flotation costs $               40,000 Time between issues (months) 60 rate on surplus funds (annual) 5% a. Perform a complete bond refunding analysis. What is the bond refunding's NPV? Initial investment outlay to refund old issue: Call premium on old issue = $      1,00,000.00 After-tax call premium = $      1,00,000.00 New flotation cost = $         40,000.00 Old flotation costs already expensed = $                        -   Remaining flotation costs to expense = $                        -   Tax savings from old flotation costs = $                        -   You get to expense the remaining flotation costs Additional interest on old issue after tax = $      7,00,000.00 This is interest paid on the old bond issue between when the new bonds are issued and the old bonds are retired Interest earned on investment in T-bonds after tax = $      5,00,000.00 This is interest earned on the proceeds from the new bonds before they are used to pay off the old bonds. Total investment outlay = $      3,40,000.00 Annual interest savings due to refunding: Annual after tax interest on old bond = $      1,40,000.00 Annual after tax interest on new bond = $      1,00,000.00 Net after tax interest savings = $         40,000.00 Annual cash flows = $         40,000.00 NPV of refunding decision = $         75,186.32 c. At what interest rate on the new debt is the NPV of the refunding no longer positive? Use Goal Seek to set cell D60 to zero by changing cell C28. "Break-even" interest rate = 10.472%

Related Questions

Navigate

• Browse (All)
• Browse F
• Subjects

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