Question

Refunding Analysis Mullet Technologies is considering whether or not to refund a $75 million, 12% coupon, 30-year bond issue that was sold 5 years ago. It is amortizing $6 million of flotation costs on the 12% bonds over the issue's 30-year life. Mullet's investment banks have indicated that the company could sell a new 25-year issue at an interest rate of 11% in today's market. Neither they nor Mullet's management anticipate that interest rates will fall below 11% any time soon, but there is a chance that rates will increase.

A call premium of 8% would be required to retire the old bonds, and flotation costs on the new issue would amount to $4 million. Mullet's marginal federal-plus-state tax rate is 40%. The new bonds would be issued 1 month before the old bonds are called, with the proceeds being invested in short-term government securities returning 5% annually during the interim period.

Conduct a complete bond refunding analysis. What is the bond refunding's NPV? Do not round intermediate calculations. Round your answer to the nearest cent.

Answer 1

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? v I . * 03-23 ENG 22-02-2020 16 X424 N O P Q R S T U V W X Y Z A 401 402 step 1 403 404 405 406 407 408 investment outlay required to refund the issue call premium on old issue 75000000 x 8% = 6000000 call premium on old issue after tax 6000000 x (1 -0.40) = 3600000 outflow new floatation cost = 4000000 outflow 409 old flotation cost= 6000000 [ 30 years life] per year cost = 200000.00 25 years life outstanding 25 years flotation cost = 5000000 tax saving on old flotation cost = 5000000 x 40% = 2000000 inflow 410 411 412 413 414 415 416 417 418 419 420 After tax additional interest for 1 month 75000000 x 12% x (1/12)*(1-0.4) 450000 outflow interest on investment value of new bonds issued = after tax return for 1 month = 421 75000000 75000000 x 5% x (1/12) x (1-0.4) = 187500 inflow 422 423 424 net cash outflow = 5862500 . ... WARRANT refund 54 55 56 57 58 59 611 Sheet12 Sheet13 S14 Sheet15 516 SS12 Sheet18 Sheet19 Sheet1 S53 S54

w ? v I . * 03-23 ENG 22-02-2020 16 X424 N o pe R S T U V W X 424 425 step 2 426 427 428 annual cash flows flotation cost on new issue flotation cost per year = tax savings on above costs = 4000000 160000 4000000/25] 64000 429 430 431 432 433 If refund is done, deduction of flotation cost forgone = deduction of flotation cost forgone = tax saving lost on above costs = 5000000/25 200000.00 80000.00 434 435 amortization tax effect = - 16000.00 436 437 438 Interest on old issue = 75000000 x 12% After tax interest payments = 9000000 5400000 439 440 Interest on new issue = 75000000 x 11% = After tax interest payments = 8250000 4950000 441 442 443 after tax net interest saving = 5400000 - 4950000 = 450000 444 445 446 447 net cash inflow 434000.00 ... WARRANT refund 54 55 56 57 58 59 611 Sheet12 Sheet13 514 Sheet15 516 5512 Sheet18 Sheet19 Sheet1 553 554

? v I . * 03-23 ENG 22-02-2020 16 X470 N O P Q R S T U V W X Y Z A 447 448 449 450 451 present value all cash inflows 434000 x PVIFA @5%, 25 YEARS 434000 X (1/r)*(1-(1/(1+r)^n)) 434000 x (1/0.05)*(1-(1/(1+0.05)^25)) = 434000 X 14.093945 = 6116771.94 452 453 454 455 456 ANSWER NPV = NPV = PV OF ALL CASH INFLOWS - OUTFLOWS 6116771.94 - 5862500 = 254271.94 457 458 459 460 462 463 464 465 466 467 468 469 470 . ... WARRANT refund 54 55 56 57 58 59 611 Sheet12 Sheet13 S14 Sheet15 516 SS12 Sheet18 Sheet19 Sheet1 S53 S54