Charles River Associates is considering whether to call either of the two perpet
ID: 2729949 • 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 $ 140,000,000 $ 147,000,000
Call premium 7.6 % 8.2 %
Transaction cost of refunding $ 13,000,000 $ 20,500,000
Current YTM 6.25 % 7.0 %
The corporate tax rate is 40 percent. 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))
Which, if either, bond should the company refinance?
Bond A
Bond B
Refund both bonds
Neither bond
Explanation / Answer
Since Both bonds gives negative NPV, Refund of both bonds should not be done.
Bond A Bond B outstanding 140,000,000 147,000,000 Coupon Rate 0 0 Interst savings p.a 9,800,000 11,760,000 Discount rate/YTM 0 0 Perpetual value of interest savigs 156,800,000 168,000,000 Less: Cash to bond holders on redeemption 150,640,000 159,054,000 Transaction cost of refunding 13,000,000 20,500,000 Net present value (6,840,000) (11,554,000) Cash to bond holders on redeemption Bond A Bond B outstanding 140,000,000 147,000,000 Add: premium 10,640,000 12,054,000 Total 150,640,000 159,054,000