Charles River Associates is considering whether to call either of the two perpet
ID: 2660225 • 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?
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 7.00 % 8.00 % Value outstanding $ 125,000,000 $ 132,000,000 Call premium 7.50 % 8.50 % Transaction cost of refunding $ 11,500,000 $ 13,000,000 Current YTM 6.25 % 7.10 % The corporate tax rate is 35 percent.What is the NPV of the refunding for each bond?
Which, if either, bond should the company refinance? Bond A Bond B Refund both bonds Neither bond
Explanation / Answer
50000
Spot Rate
forward
2-Nov
1.6021
31-Dec
1.582
1-Mar
-0.0201
Spot rate
-1005
0.0723
1.5927
1.58
1.6543
3615
INTEREST
Coupon rate
Value outstanding
Call premium
Transaction cost of refunding
Current YTM
Tax
Net Saving
$1,875,000
$656,250
$1,218,750
($1,937,500)
($678,125)
($1,259,375)
(B)
company should finance BOND B