New York Waste (NYW) is considering refunding a $50,000,000, annual payment, 14%
ID: 2696331 • 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 10% 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. Should the bonds be refunded? Calculate the NPV of refunding.
Explanation / Answer
Here is how I understood it.
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