Question 1:

Eight years ago, NZ Ltd made the following debenture issue on the following terms:

Amount: $12,000,000

Term: 20 years

Interest rate: 11%

Flotation costs: $230,000

Flotation costs are being amortised over the term of the debentures. Due to changes in interest rates, NZ Ltd is considering redeeming the current issue of debentures and making a new issue for 12 years at an interest rate of 9.5% per annum. The flotation costs of the new issue will be $138,000.

To make the offer more attractive to existing debenture holders, NZ Ltd will pay a premium of 3.5% on the redeemed debentures. There will be a 4-month overlap period between the issuing of the new debentures and the repayment of the existing ones. Assume a tax rate of 28% and that the discount rate is the after-tax cost of the new debentures.

Advise the management of NZ Ltd on whether to proceed with the refinancing of the debentures.