CTI Inc. issues 500 callable bonds with par value of $1,000. This callable bond pays 20% annual coupon and matures in 20 years. Its yield is 16% and it is callable at the end of year 5 at par value plus one additional coupon payment.

Yield at end of Year 5

Probability

30%

40%

20%

30%

10%

30%

a) What is the price of the bond if it were not callable?

b) What is the price of the callable bond?

c) Assume at the end of year 5, CTI calls the bonds and replaces them by a 15-year bond selling at par. The flotation cost is 1% of the par value. CTI has to issue the new bonds one month before calling. During the month, the proceeds will earn 4% per year. The tax rate is 0.3. What is the NPV of refunding?