#1Charles River Associates is considering whether to call either of the two perpetual bond issues the company currently has outstanding. If the bond is called, it will be refunded, that is, a new bond issue will be made with a lower coupon rate. The proceeds from the new bond issue will be used to repurchase one of the existing bond issues. The information about the two currently outstanding bond issues is:

Bond A Bond BCoupon rate 7 % 8 %

Value outstanding $ 138,000,000 $ 145,000,000

Call premium 7.6 % 8.2 %

Transaction cost of refunding $ 12,800,000 $ 19,500,000

Current YTM 6.25 % 6.9 %

The corporate tax rate is 40 percent. What is the NPV of the refunding for each bond?

NPV Bond A $ Bond B $

Which, if either, bond should the company refinance?

Bond ABond

BRefund

both bonds

Neither bond

2. Consider the prices of the following three Treasury issues as of February 24, 2012: 7.050 May 17 110.31250 110.37500 12 5.39 8.030 May 17 107.43750 107.50000 4 5.35 11.780 May 17 145.93750 146.12500 14 5.43

The bond in the middle is callable in February 2013. What is the implied value of the call feature?

(Hint: Is there a way to combine the two noncallable issues to create an issue that has the same coupon as the callable bond?) Call value $