The Lavely Company issued $2 million of 30-year, $1,000 bonds with a coupon rate of 8 percent five years ago. The bonds with a call price of $1,060 were sold at a discount rate of $20 per bond or with a total discount of $40,000. The initial flotation cost was $25,000. The company wished to sell a $2 million new issue of 6 percent, 25-year bonds in order to retire its existing bonds. The company intends to sell new bonds at their face value of $1,000 per bond. The flotation cost of the new issue is estimated to be $30,000. The companys marginal tax rate is 40 percent and the new bonds are sold four months before the old bonds are called.

a) Determine the net cash outflow of the refunding operation.

b) Determine the annual interest savings of the refunding operation.

c) Determine the present value of the interest saving over a 25-year period at a 3.6 percent discount rate.

d) Should the company refund its old bonds?

e) Use the internal rate of return approach to determine whether the company should refund its old bonds or not.