Charles River Associates is considering whether to call either of the two perpetual bond issues the company
Question:
The corporate tax rate is 35 percent. What is the NPV of the refunding for each bond? Which, if either, bond should the company refinance? Assume the call premium is tax deductible.
Bond A Bond B Coupon rate Value outstanding Call premium Transaction cost of refunding Current YTM 8.00% $125,000,000 $132,000,000 7,50% 8.50% 11,500,000 13,000,000 6.25% 71 0%
Step by Step Answer:
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Corporate Finance
ISBN: 978-0077861759
10th edition
Authors: Stephen Ross, Randolph Westerfield, Jeffrey Jaffe
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Bond valuation is the process of determining the worth of a bond. It is based on the present value of the bond\'s future cash flows, which include coupon payments and the return of the bond\'s face value (or \"principal\") at maturity. The discount rate used in the calculation is directly tied to prevailing interest rates, and a rise in interest rates will decrease the present value of the bond and thus lower its price. Conversely, a fall in interest rates will increase the present value of the bond and raise its price. Interest rates serve as a benchmark for determining the value of a bond, as they determine the discount rate used in the bond valuation calculation. The most commonly used measure of interest rates is the yield to maturity (YTM), which represents the internal rate of return of an investment in a bond if the investor holds the bond until maturity and receives all scheduled payments. Yield to maturity is a function of the coupon rate, the current market price of the bond, the face value of the bond, and the number of years remaining until maturity. By comparing the yield to maturity of a bond to prevailing market interest rates, an investor can assess the relative value of the bond.
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