Vincent Marchiano is opposed to calling the bonds now because he thinks that the decline in interest rates is not yet over and that refunding should occur one year hence.

What is the NPV of the bond refunding (in todays dollars) in this situation? Hint: Calculate the expected NPV of refunding next year based on the probability distribution of interest rates given in the case. In doing this, remember that: (1) If the NPV at a particular interest rate is negative, then Senior Care would not refund; (2) one year from now there will be 24 years remaining on the old bond, so assume the maturity of the new issue will be 24 years, and; (3) future dollars must be discounted and the interest rate one-year hence is relatively uncertain.

What do you think about Marchianos argument?

In general, how might the current shape of the yield curve influence the decision as to refund now versus later?

INPUT DATA: Original Bond Issue Size of issue Old bond coupon rate Old flotation cost Original maturity of old issue Years remaining on old bond Proposed Bond Issue New bond coupon rate New issue flotation cost Maturity of new issue Other Data ax rate MODEL GENERATED DATA: STANDARD ANALYSIS: Current Call Premium: Cost of Refunding at t 0: Call premium on old issue Flotation cost on new issue Tax savings on old float exp Net investment outlay After-tax Flotation Cost Effects: New issue flotation costs Tax benefit lost on old float Net PV of flotation cost effects nterest Savings Due to Refunding Annual payment (old bond) Annual payment (new bond) Net annual savings and PV NPV of the Refunding Decision: KEY OUTPUT: $100,000,000 NPV $3,817,019 8.0% $1,500,000 30 25 7.0% $1,000,000 25 40.0% 8.0% Amount Amount Present Before Tax After Tax Value ($8,000,000 ($4,800,000) ($4,800,000 (1,000,000 500,000 500,000 1,250,000 $5,300,000 $40,000 $244,752 $16,000 (20,000) (50,000) 305,940 $61,188 $4,800,000 $8,000,000 (7,000,000) 4,200,000 $600,000 $9,178,207 $3,817,019 END INPUT DATA: Original Bond Issue Size of issue Old bond coupon rate Old flotation cost Original maturity of old issue Years remaining on old bond Proposed Bond Issue New bond coupon rate New issue flotation cost Maturity of new issue Other Data ax rate MODEL GENERATED DATA: STANDARD ANALYSIS: Current Call Premium: Cost of Refunding at t 0: Call premium on old issue Flotation cost on new issue Tax savings on old float exp Net investment outlay After-tax Flotation Cost Effects: New issue flotation costs Tax benefit lost on old float Net PV of flotation cost effects nterest Savings Due to Refunding Annual payment (old bond) Annual payment (new bond) Net annual savings and PV NPV of the Refunding Decision: KEY OUTPUT: $100,000,000 NPV $3,817,019 8.0% $1,500,000 30 25 7.0% $1,000,000 25 40.0% 8.0% Amount Amount Present Before Tax After Tax Value ($8,000,000 ($4,800,000) ($4,800,000 (1,000,000 500,000 500,000 1,250,000 $5,300,000 $40,000 $244,752 $16,000 (20,000) (50,000) 305,940 $61,188 $4,800,000 $8,000,000 (7,000,000) 4,200,000 $600,000 $9,178,207 $3,817,019 END