Question

g Mullet Technologies is considering whether or not to refund a $175 , 125 , 30 year bond that was sold 5 years ago. It is no bonds over the issue's 30-year WeMullet's investment banks have indicated that the company could sell a new 25 years at an interest rate of Mullet's management anticipate that werest rates will fall below any time soon, but there is a chance that rates will increase 3 m on of flotation on the 12 in today's market. Neither they A call premium of 1296 would be required to retire the old bonds, and notation costs on the new issue would amount to s million, Muller's marginal federal plus state tax rate is con. The now bonds would be su 1 month to the bonds we cred, with the proceeds bevested in short-term government securit y during the tempered a. Conduct a complete band refunding analyses What is the band refunding's NPV? Do not round watermediate calculation Round your answer to the nearest cent b. What factors would influence Mutter's decision to refund now rather than later?

Answer 1

NPV analysis of bond-refunding:
Initial outlays/investments:	Mlns.
After-tax call premium(175*12%*(1-40%))	12.6
Flotation costs of new issue	3
Less:Tax savings from remaining unamortised flotation costs of old issue ($ 3 mln./30 yrs.*25 yrs.*40%)	-1
1 mth. After-tax Coupon interest on old bond(175*12%/12*(1-40%))	1.05
Less: 1 mth. After-tax interest earned on ST investments (175*7%/12*(1-40%))	-0.6125
Total Initial outlay involved	15.0375
Annual cash flows:
Tax savings on new flotation costs(3/25*40%)	0.048
Tax savings lost on old flotation costs(3/30*40%)	0.04
Net incremental tax savings on new issue	0.008
Interest savings on new issue
Annual after-tax interest on old bonds(175*12%*(1-40%))	12.6
Annual after-tax interest on new bonds(175*9%*(1-40%))	9.45
Interest savings on new issue	3.15
Total Annual cash flows(0.008+3.15)	3.158
NPV of the Bond Refunding Decision =PV of annual cash flows-Initial outlay
ie.(3.158*11.65358)-15.0375=                             ( P/A,i=7%,n=25 yrs.--11.65358)
21.764506
ie. $ 21764506 mlns.

b.Factors that affect the bond refunding decision, now or later:

As seen from above,

the NPV of the decision--ie. Its effect on shareholders' wealth--it is recommended, if positive wealth is created, ie. When NPV of the cash flows involved is POSITIVE.

for this , the prevailing interest rate of the new issue , is one of the main factors , to be considered.

Also current opportunity cost of funds , ie . As in the above case, the rate of return on investible surplus, decided the PV of the cash flows involved.