Question

all question of 10

Bood 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: 10. Bond A Bond B Coupon rate Value outstanding Call premium Transaction cost of refunding 8.00% $132,000,000 8.50% $ 13,000,000 7.10% 7.00% $125,000,000 7.50% $ 11,500,000 6.25% Current YTM

Answer 1

Bond A

NPV = PV of gain – PV of cost

PV of gain = value of the bond x(coupon rate – ytm)/ ytm

                     = 125,000,000x (0.07-0.0625)/ 0.0625

                     = 15,000,000

Assume there is tax benefit on call premium:

PV of cost = value of the bond x call premium x(1- tax rate) +cost of refunding x (1- tax rate)

                     = 125,000,000x 0.075 x( 1-0.35) + 11,500,000x(1-0.35)

                     = 6,093,750 + 7,475,000

                     = 13,568,750

Npv = 15,000,000 - 13,568,750

                = $1,431,250

Bond B

NPV = PV of gain – PV of cost

PV of gain = value of the bond x(coupon rate – ytm)/ ytm

                     = 132,000,000x(0.08-0.0710)/ 0.0710

                     = 16,732,394

Assume there is tax benefit on call premium:

PV of cost = value of the bond x call premium x(1- tax rate) +cost of refunding x (1- tax rate)

                     = 132,000,000x 0.08 x( 1-0.35) + 13,000,000x(1-0.35)

                     = 6,864,000 +8,450,000

                     = 15,314,000

Npv = 16,732,394 -15,314,000

                = $1,418,394

Bond A should be chosen since its NPV is higher.