Refunding Analysis

Mullet Technologies is considering whether or not to refund a $75 million, 14% coupon, 30-year bond issue that was sold 5 years ago. It is amortizing $6 million of flotation costs on the 14% bonds over the issue's 30-year life. Mullet's investment banks have indicated that the company could sell a new 25-year issue at an interest rate of 10% in today's market. Neither they nor Mullet's management anticipate that interest rates will fall below 10% any time soon, but there is a chance that rates will increase.

A call premium of 8% would be required to retire the old bonds, and flotation costs on the new issue would amount to $4 million. Mullet's marginal federal-plus-state tax rate is 40%. The new bonds would be issued 1 month before the old bonds are called, with the proceeds being invested in short-term government securities returning 5% annually during the interim period.

1. Conduct a complete bond refunding analysis. What is the bond refunding's NPV? Do not round intermediate calculations. Round your answer to the nearest cent.
2. What factors would influence Mullet's decision to refund now rather than later?

18-07 Refunding Analysis Par Value $75,000,000 coupon rate 14% original maturity 30 remaining maturity 25 original flotation costs $6,000,000 Call premium 8% tax rate 40% new issue information Coupon rate 10% maturity 25 flotation costs $4,000,000 time between issue (months) 1 month annual rate on surplus refunds 5% Call premium of old issue=$75,000,000*8% $6,000,000 After tax cal premium=$6,000,000*(1-40%) $3,600,000 3600000 New Flotation costs $4,000,000 old floation costalready expensed $6,000,000/25*(30-25) $1,200,000 1200000 remaining flotation costs to expense= $4,800,000 $6,000,000-$1,200,000 Tax savings from old flotation costs= $1,920,000 $4,800,000*40% Additional interes on old issue after tax $525,000 525000 $75,000,000*14%*1/12*(1-40%) Interest earned on investments in t-bonds after tax $187,500 187500 $75,000,000*5%*1/12*(1-40%) TOTAL INVESTMENT= $6,017,500 Annual Flotation cost tax effects: Annual tax savings on new Flotation $64,000 $4,000,000*40%/25 Tax savings lost on oldflotation $80,000 $6,000,000*40%/30 Tax amortization tax effects ($16,000) Annual interest savings due to refunding: Annual after tax interest on old bond $6,300,000 6300000 $75,000,000*14%*(1-40%) Annual after tax interest on newbond $4,500,000 4500000 $75,000,000*10%*(1-40%) NET after tax interest savings $1,800,000 Annual cash flows= $1,784,000 A.NPV of refunding decision $19,126,097.11 B. Factors that influence Mullet's Decision to refund would be whethe the interest rate will increase or decrease, if the IR increases rufund now, if it decreases Mullut should wait.He should analze what impact it will be on investors if the olf bond is called.