To finance a new project, JPE Inc. will issue a 10-year, 12% coupon callable bond (For simplicity, assume coupons are paid annually). The current required yield is 12%. At the end of year 3, there is a 30% probability that the yield will be 5% and 70% probability that the yield will be 16%. The bond will be called at $1,000 (the par value) plus one additional coupon payment if the bond price is higher than the call price.

a) What is the callable bond price?

b) If JPE wants to issue the callable bond at $1,050, what must the coupon rate be?

c) Assume that the yield changes to 5% at the end of year 3, JPE replaces the bond (in part a) with a new 7-year bond (issued at par). The flotation cost is $80 per bond. The new bond will be parked in the money market to earn 2% (per year) interest during the 30-day overlap period. The tax rate is 40%. What is the NPV of the bond refund?