Dillon Inc., an American company, is contemplating offering a new $100 million bond issue to replace an outstanding $100 million bond issue. The company wishes to take advantage of the decline in interest rates that has occurred since the initial bond issuance. The old and new bonds are described in what follows. The company is in the 30% tax bracket. The company expects to pay overlapping interest for three months. Old bonds: The outstanding bonds have a $1,000 face value and an 8% coupon interest rate. They were issued five years ago with a 20-year maturity. They were initially sold at a discounted price of $980, and the company incurred $450,000 in flotation costs. They are callable at $1,080. New bonds: The new bonds would have a $1,000 face value, a 6% coupon interest rate, and a 15-year maturity. They would be sold at their face value. The flotation cost of the new bonds would be $500,000.

Show workings step by step calculations

a. Determine the total initial investment that is required to recall the old bonds and issue the new bonds.

b. Calculate the annual cash flow savings, if any, that are expected from the proposed bond-refunding decision.

c. If the company has a 4.2% after-tax cost of debt, find the net present value (NPV) of the bondrefunding decision.

Would you recommend the proposed refunding? Explain your answer.