Northern Distributors has $40 million in bonds outstanding that carry a 12 percent coupon rate paid annually. These bonds have 10 years to maturity and a call premium of 6 percent. As the yield on current bonds is 9.5 percent the company is considering refunding their bonds. A new issue would require $1 million in flotation costs. In addition, an overlap period of one month is anticipated, during which time money market rates would be 7 percent. Northern Distributors has a tax rate of 40 percent.

Required: Advise Northern Distributors whether or not they should refund the bond. Show all calculations. (15 marks)