Question

Refunding Analysis Mullet Technologies is considering whether or not to refund a $ 5 million, 12. coupon, 30 year bond issue that was sold 5 years ago. It is amortizing $3 million of flotation costs on the 129 bonds over the issue's 30-year life. Mullet's investment banks have indicated that the company could sell a new 25 years at an interest rate of 9% in today's market. Neither they nor Mullet's management anticipate that interest rates will fall below 9% any time soon, but there is a chance that rates will increase the new A call premium of 129 would be required to retire the old bonds, and flotation costs on the new issue would amount to $3 min. Mullet's marginal federal plus state tax rate is bonds would be issued 1 month before the old bonds are called, with the proceeds being invested in short-term government securities returning annually during the term period descent a. Conduct a complete bond refunding analysis. What is the band refunding's NPV? Do not round intermediate calculations. Round your answer to the b. What factors would influence Mulet's decision to refund now rather than later?

Answer 1

a]

The initial investment outlay to refund the old issue = after-tax call premium on old issue + new flotation cost - tax savings from old flotation costs + additional interest on old issue after tax - interest earned on investments in interim period

after-tax call premium on old issue = par value of old issue * call premium * (1 - tax rate)

tax savings from old flotation costs = (old flotation costs - old flotation costs already expensed) * tax rate

additional interest on old issue after tax = interest paid on old bonds during interim period

interest earned on investments in interim period = interest earned on proceeds of new bonds during interim period

Annual incremental cash flows = After-tax interest savings + Flotation cost amortization tax effects

After-tax interest savings = after-tax interest on new bonds - after-tax interest on old bonds

Flotation cost amortization tax effects = annual tax savings on new flotation - tax savings lost on old flotation

NPV of bond refunding = present value of annual incremental cash flows - initial investment outlay

In calculating the present value of annual incremental cash flows, the discount rate used is the rate of return earned on short-term investments in the interim period (7%)

NPV of bond refunding = $21,764,515.68

1 Bond Refunding Analysis Current band irreisfarsities $ 175,...,... r CEP rate original sterity isinaturity original flataties curt Call presies 14 Meu irrueisfarsities 19 Tis. Keturtarria (est) 20 rate in rurplu fondanza) 21,...,...... 12,4......... 23 Initializzata stretla tarafat aldirst: 24 Call presies dies. 25 After-tax call prani- 26 Meu flatation cut- 27 Oldflatatins eru already + p 28 Renaising flataties c ute +p+w+- 29 Turuviner fred flatutis cut- 30 Additionalisterert en al die after tar- 31 laterart maradan invertnest in T-band after tas 2,5......... 1........... Te t +p+v.ther+ndinis flatetims cut 1,05........ Thir ir interart paid on the bands.betu.subestb.subasdar.irstand the bear retired $12,5.... Thir ir interart earned the proc.drfrostb. subend before they ar. tp yoff the band. 15.37.5 .1 $ 34 Am Flotatis. Cut Tax Effect: 35 ALBteriviLeR U flotation - 36 Taraviny lutas old flataties - 37 Total asortization tax effect - 39 Annalisterertraviny de terefinding: 40 AR. al after tar interer- $ 12,4......... 9,45.,...... 44 Anualcul flour - 0 3.151.000.00 46 HPT of refunding deciris- 21.762 515.6+

Bond Refunding Analysis Current badire informatie CO POR rete riginal-turity turity original flatstis cut r Hautifuritius Tizebetueen rar (at) rute enrerplafond (anal) 23 Initial intarta strutlay to refundadir: 24 Call praisaldirst- Aftur-ta sullruni- 26 Meu flotatis cut- On Flatatizs suur already +P+wa- Resinin flatutins cutr t + + + Tax review from old flataties cut- 30 Additional interart mollire. after tar- 31 Isterartersdenisvartdestin T-band after tus - 32 Totalisvert at rutlay - -C1-C5 -D24 (1-C11) -C17 -(C9/07)"(07-C#) -C2-D27 -C11 D2+ -C5-C6"(19/12)(1-C11) -C17-C11C16 34 Anal FlotatisCut Tax Effect: 35 Annual tax raviny a neu flotation - 36 Tarvinylut old flotation - 37 Totalisartization truffest - 39 Ass listerart revine de tarefading: 40 ABR aftorte intorert kollO- Ameal after taxisterart en soubut- Het after taxisterartraviny - -C5-C6 (1-C11) -C5C151-611) 44 Assal earlfleur- -D37+042 HPT of refunding deciries - --D32-P (cz.,C16,044,0)

b]

Management anticipates that interest rates will not fall below today's interest rate of 9% anytime soon, but there is a chance that rates will increase.

This would influence Mullet to refinance now, and take advantage of the lower interest rates, rather than refund later when there is a chance that interest rates may be higher.