Refunding Analysis South Tel Technologies is considering whether or not to refund a $90 million, 8% annual coupon, 30-year bond issue that was sold 5 years ago. South Tels investment banks have indicated that the company could sell a new 25-year issue at an interest rate of 6.5% (annual payments) in todays market. Neither they nor South Tels management anticipate that interest rates will fall below 6.5% any time soon, but there is a chance that rates will increase.

A call premium of 7% would be required to retire the old bonds, and flotation costs on the new issue would amount to $6 million. South Tels tax rate is 30%. 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 2% annually during the interim period. Should South Tel refund its outstanding bonds?