Charles River Associates is considering whether to call either of the two perpet
ID: 2612224 • 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:
What is the NPV of the refunding for each bond? (Do not round intermediate calculations and round your final answers to 2 decimal places. (e.g., 32.16))
Bond A Bond B Coupon rate 7 % 8 % Value outstanding $ 127,000,000 $ 134,000,000 Call premium 7.5 % 8.5 % Transaction cost of refunding $ 11,700,000 $ 14,000,000 Current YTM 6.25 % 7.1 %
Explanation / Answer
Bond A:
Gain = $ 127,000,000 (.07 – .0625) / .0625
Gain = $15240000
After tax cost of refinance
Cost = $127,000,000 (.075)(1 – .35) + $11,700,000 (1 – .35)
Cost = $13796250
The NPV of refunding this bond is:
NPV = –$10,643,750.00 + 10,714,285.71
The NPV of refunding this bond is:
NPV = –$13796250 + 15240000= 1443750
The NPV of refunding the second bond is:
Bond B:
Gain = $ 134,000,000 (.08 – .071) / .071
Gain = $16985915.49
After tax cost of refinance
Cost = ($134,000,000)(.085)(1 – .35) + $14,000,000 (1 – .35)
Cost = $16503500
The NPV of refunding this bond is:
NPV = –$16503500 + 16985915.49
NPV = $482415
NPV of both refunding is positive so both bond company should refinance.