Onex Inc. issues a callable bond with maturity of 15 years. The yield is 0.15 which is the same as the coupon rate. At the end of year 2, the yield will be either 0.2 with 40% probability or 0.075. The bond is callable at the par value ($1,000) plus two additional coupon payments. The tax rate is 0.3. For simplicity, assume annual coupons.

a) What is the price of the callable bond?

b) Assume at the end of year 2, Onex calls the bond and replaces it by a thirteen-year bond selling at par. The flotation cost is $100. Onex has to issue the new bond one month before calling. During the month, the proceeds will earn 5% per year. What is the NPV of refunding?