Charles River Associates is considering whether to call either of the two perpet
ID: 2382514 • Letter: C
Question
Charles River Associates is considering whether to call either of the two perpetual bond issues the company currently has outstanding. If the bond is called, it will be refunded, that is, a new bond issue will be made with a lower coupon rate. The proceeds from the new bond issue will be used to repurchase one of the existing bond issues. The information about the two currently outstanding bond issues is:
Bond A
Bond B
Coupon Rate
7%
8%
Value outstanding
$131,000,000
$138,000,000
Call premium
7.4%
8.1%
Transaction cost of refunding
$12,100,000
$16,000,000
Current YTM
6.25%
7.0%
The corporate tax rate is 35 percent.
What is the NPV of the refunding for each bond?
NPV for Bond A is
NPV for Bond B is
Which, if either, bond should the company refinance?
A) Bond A
B) Bond B
C) Refund both bonds
D) Neither bond
Charles River Associates is considering whether to call either of the two perpetual bond issues the company currently has outstanding. If the bond is called, it will be refunded, that is, a new bond issue will be made with a lower coupon rate. The proceeds from the new bond issue will be used to repurchase one of the existing bond issues. The information about the two currently outstanding bond issues is:
Bond A
Bond B
Coupon Rate
7%
8%
Value outstanding
$131,000,000
$138,000,000
Call premium
7.4%
8.1%
Transaction cost of refunding
$12,100,000
$16,000,000
Current YTM
6.25%
7.0%
Explanation / Answer
Bond A Bond B Value of Bond 131,000,000.00 138,000,000.00 Coupon Rate 7% 8% Call Premium 7.40% 8.10% Call Premium 9,694,000.00 11,178,000.00 Transaction Cost of Refunding 12100000 16000000 Current YTM 6.25% 7% Tax Rate 35% 35% After Tax YTM 4.0625 4.55 Let new coupon rate decreased by 1% Net Initial Outflows Repayment of Old Bond with premium 140,694,000.00 154,000,000.00 Less :Net Proceeds from new Bond 118,900,000.00 122,000,000.00 Less:Tax Saving on Premium 3,392,900.00 3,912,300.00 Net Initial Outflows 18,401,100.00 28,087,700.00 Annual Saving in Interest (Value *2%) assumed 2,620,000.00 2,760,000.00 Decrease in Tax Saving on Interest (saving in Int*35%) 917,000.00 966,000.00 Annual Saving 1,703,000.00 1,794,000.00 PV of Annual Saving 851500*PVIFA(4.0625%,5) 7,568,132.000 7,864,896.000 897000*PVIFA(4.55%,5) NPV=Pv of annual saving - initial outflows (10,832,968.000) (20,222,804.000)