New York Waste (NYW) is considering refunding a $50,000,000, annual payment, 14%
ID: 2653560 • Letter: N
Question
New York Waste (NYW) is considering refunding a $50,000,000, annual payment, 14% coupon, 30-year bond issue that was issued 5 years ago. 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. NYW's marginal tax rate is 40%. The new bonds would be issued when the old bonds are called.The amortization of flotation costs reduces taxes and thus provides an annual cash flow.
a) What will the net increase or decrease in the annual flotation cost tax savings be if refunding takes place?
b)What will the after-tax annual interest savings for NYW be if the refunding takes place?
c) What is the required after-tax refunding investment outlay, i.e., the cash outlay at the time of the refunding?
(PLEASE SHOW ALL WORK AND CALCULATIONS)
New York Waste (NYW) is considering refunding a $50,000,000, annual payment, 14% coupon, 30-year bond issue that was issued 5 years ago. 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. NYW's marginal tax rate is 40%. The new bonds would be issued when the old bonds are called.The amortization of flotation costs reduces taxes and thus provides an annual cash flow.
a) What will the net increase or decrease in the annual flotation cost tax savings be if refunding takes place?
b)What will the after-tax annual interest savings for NYW be if the refunding takes place?
c) What is the required after-tax refunding investment outlay, i.e., the cash outlay at the time of the refunding?
(PLEASE SHOW ALL WORK AND CALCULATIONS)
Explanation / Answer
Amount: $50,000,000 Call premium %: 14%
Old rate: 14.00% Tax rate: 40%
Original life: 30 New rate: 11.67%
Years ago issued: 5 New life: 25
Orig. flotation cost: $3,000,000 New flotation cost: $3,000,000
Years remaining on old bond: 25
Old issue flotation costs:
Remaining unexpensed = (25/30)($3) = $2,500,000
Tax saving on unexpensed float cost = $2.5(T) = $2.5(0.4) =-1,000,000
After tax cost of call premium: 0.14($50)(0.6) = 4,200,000
Flotation costs on new issue: 3,000,000
Net after-tax cost to call the bonds: 6,200,000
B.
Old interest: $50,000,000(0.14)(0.6) = $4,200,000
New interest: $50,000,000(0.1167)(0.6) = (3,501,000)
Net annual interest savings $699,000
C.
Flotation costs benefit, new: ($3.00/25)(0.4) = $48,000
Flotation costs lost, old: ($3.00/30)(0.4) = (40,000)
Net annual amortization tax effects = $ 8,000
D.
Appropriate discount rate = New bond cost (1 ? T) = 7.002%
Financial calculator solution:
Inputs: N = 25; I/YR = 7.0; PMT = 699,000 + 8,000 = 707,000; FV = 0.
Output: PV = -$8,237,599 = PV of savings =$8,237,599
Cost to refund = 6,200,000
NPV of the refunding = $2,037,599
Hope this helps.