Oklahoma Service Company is contemplating offering a new $150 million bond issue to replace an outstanding $150 million bond issue to take advantage of a recent decline in interest rates. The old and new bonds are described below. The firm is in the 35 percent tax bracket.

Old bonds The outstanding bonds have a $1,000 par value and a 7.0 percent coupon interest rate. They were issued 5 years ago with a 15-year maturity. They were initially sold for their par value of $1,000, and the firm incurred $500,000 in flotation costs. They are callable at $1,070.

New bondsThe new bonds would have a $1,000 par value and a 5.7 percent coupon interest rate. They would have a 10-year maturity and could be sold at their par value. The flotation cost of the new bonds would be $750,000. The firm does not expect to have any overlapping interest.

a. Determine the initial investment required to call 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 firm has a 4.0 percent average after-tax cost of debt, find the net present value (NPV) of the bond-refunding decision. Would you recommend the proposed refunding? Why or why not?