Providence Industries has an outstanding debenture of $25 million that was issued when flotation costs could be expensed immediately. It carries a coupon rate of 10 percent and has 15 years to maturity. Currently, similar risk bonds are yielding 9 percent over a 15-year period, and Providence is wondering if a refunding would be economically sound. The existing debenture has a call premium of 5 percent at present. It is estimated that a new issue would require underwriting costs of $470,000 and other costs of $80,000. No overlap period would be required. Providence Industries has a tax rate of 25 percent. Its cost of capital is 16 percent.

a.Should Providence Industries refund the old issue? Show your calculations.

b.Discuss your choice of discount rate.

c.Suppose the refunding was not justified economically. What other reasons might Providence have for refunding the old issue?