Problem 15-10 Bond Refunding Charles River Associates is considering whether to
ID: 2772967 • Letter: P
Question
Problem 15-10 Bond Refunding
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? (Do not round intermediate calculations and round your final answers to 2 decimal places. (e.g., 32.16))
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
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))
Bond A
Transaction cost of refunding = $ 12,300,000
Call Premium = 133,000,000*7.6% = $ 10108000
Total Initial Cash outlay = 12,300,000 + 10108000
Total Initial Cash outlay = $ 22,408,000
Tax Saving on Call Premium & Transaction cost of refunding = (10108000+12,300,000)*40%
Tax Saving on Call Premium & Transaction cost of refunding = $ 8,963,200
Annual Cash Saving = (7%-6.25%)*133,000,000*(1-40%)
Annual Cash Saving = 598500
NPV = -initial outlay + Tax Saving on Call Premium & Transaction cost of refunding/(1+r) + Annual Cash Saving /r
NPV = -22,408,000 + 8,963,200/1.0625 + 598500/6.25%
NPV = - 4,396,047.06
Bond B
Transaction cost of refunding = $ 17,000,000
Call Premium = 140,000,000*8.4% = $ 11760000
Total Initial Cash outlay = 17,000,000 + 11760000
Total Initial Cash outlay = $ 28,760,000
Tax Saving on Call Premium & Transaction cost of refunding = 28,760,000*40%
Tax Saving on Call Premium & Transaction cost of refunding = $ 11,504,000
Annual Cash Saving = (8%-7.1%)*140,000,000*(1-40%)
Annual Cash Saving = 756000
NPV = -initial outlay + Tax Saving on Call Premium & Transaction cost of refunding/(1+r) + Annual Cash Saving /r
NPV = -28,760,000 + 11,504,000/1.071 + 756000/7.1%
NPV = - 7,370,749.46
As NPV of both bond is negative
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))