22. Mike Garcia, the chief financial officer of Endicott Publishing Co., could hardly believe the change in interest rates that had taken place over the last few months. The interest rate on A2 rated bonds was now 8 percent. The $30 million, 15-year bond issue that his firm has outstanding was initially issued at 11 percent five years ago.

Because interest rates had gone down so dramatically, he was considering refunding the bond issue. The old issue had a call premium of 10 percent. The underwriting cost on the old issue had been 3 percent of par and on the new issue, it would be 4 percent of par. The tax rate would be 40 percent and a 5 percent discount rate will be applied for the refunding decision. The new bond would have a 10-year life.

Before Mike used the 10 percent call provision to reacquire the old bonds, he wanted to make sure he could not buy them back cheaper in the open market.

a. First compute the price of the old bonds in the open market. Use the valuation procedures for a bond that were discussed in Chapter 10 (use the annual analysis).

Determine the price of a single $1,000 par value.

Compare the price in part a to the 10 percent call premium over par value. Which appears to be more attractive in terms of reacquiring the old bonds?

Now do the standard bond refunding analysis as discussed in this chapter. Is the refunding financially feasible?

In terms of the refunding decision, how should Mike be influenced if he thinks interest rates might go down even more?