Charles River Associates is considering whether to call either of the two perpet
ID: 2612495 • 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
$
139,000,000
$
146,000,000
Call premium
7.6
%
8.1
%
Transaction cost of refunding
$
12,900,000
$
20,000,000
Current YTM
6.25
%
7.0
%
The corporate tax rate is 35 percent.
What is the NPV of the refunding for each bond?
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:
Explanation / Answer
Bond A
Coupon payment saved = 7 * (1-0.35) * 139000000 = 6324500
Value Outstanding = 139000000
Call Premium = 0.076 * 139000000 = 10564000
NPV = PV of Inflows - PV of Outflows
Present value of perpetual bonds =Annuity / YTM
= 6324500 / 0.0625
= 101192000
NPV = 1,01,192,000 - (139000000+12900000+10564000)
= - 61272000
Bond B
Coupon Payment saved = 146000000* 8% * (1-0.35)
= 7592000
Pv OF Inflows = 7592000 / 0.07
= 1,08,457,142
Value Outstanding = 146000000
Premium = 146000000 * 0.081
= 11826000
Total outflow = 146000000+11826000 + 20000000
= 177826000
NPV = 1,08,457,142 -177826000
= - 69368858
Inflow here is considered is saving in net of tax coupon payment which is going to come as a result of calling back the bond.