New York Waste (NYW) is considering refunding a $50,000,000, annual payment, 14%

Question

New York Waste (NYW) is considering refunding a $50,000,000, annual payment, 14% coupon, 30-year bond issue that was issued 5 years ago. It has been amortizing $3 million of flotation costs on these bonds over their 30-year life. The company could sell a new issue of 25-year bonds at an annual interest rate of 11.67% in today's market. A call premium of 14% would be required to retire the old bonds, and flotation costs on the new issue would amount to $3 million. NYW's marginal tax rate is 40%. The new bonds would be issued when the old bonds are called.


What is the NPV if NYW refunds its bonds today?

I am trying to ensure that I have this correct, requesting confirmation. when using the tool provided through excel I get a number closes to 1, 837,823,80 but searching your data base it contains 2,037,599. what could be causing the descripancy. Please review and tell me what I am doing wrong.
Current bond issue information
Par value $50,000,000
coupon rate 14%
original maturity 30
remaining maturity 25
original flotation costs $3,000,000
Call premium 14%
Tax rate 40%


New issue information
Coupon rate 11.7%
maturity 25
flotation costs $3,000,000

Time between issues (months) 1
rate on surplus funds (annual) 6%

a. Perform a complete bond refunding analysis. What is the bond refunding's NPV?

Initial investment outlay to refund old issue:
Call premium on old issue = 7,000,000.00
After-tax call premium = 4,200,000.00
New flotation cost = 3,000,000.00
Old flotation costs already expensed = 500,000.00
Remaining flotation costs to expense = 2,500,000.00
Tax savings from old flotation costs = 1,000,000.00
Additional interest on old issue after tax = 1,750,000.00
Interest earned on investment in T-bonds after tax = 750,000.00
Total investment outlay = 7,200,000.00

Annual Flotation Cost Tax Effects:
Annual tax savings on new flotation = 48,000.00
Tax savings lost on old flotation = 40,000.00
Total amortization tax effects = 8,000.00

Annual interest savings due to refunding:
Annual after tax interest on old bond = 4,200,000.00
Annual after tax interest on new bond = 3,501,000.00
Net after tax interest savings = 699,000.00

Annual cash flows = 707,000.00

NPV of refunding decision = $1,837,832.80

Explanation / Answer

Here is how I understood it.

Amount: $50,000,000 Call premium %: 14% <?xml:namespace prefix = o ns = "urn:schemas-microsoft-com:office:office" /?>

Old rate: 14.00% Tax rate: 40%

Original life: 30 New rate: 11.67%

Years ago issued: 5 New life: 25

Orig. flotation cost: $3,000,000 New flotation cost: $3,000,000

Years remaining on old bond: 25

Old issue flotation costs:

Remaining unexpensed = (25/30)($3) = $2,500,000

Tax saving on unexpensed float cost = $2.5(T) = $2.5(0.4) =-1,000,000

After tax cost of call premium: 0.14($50)(0.6) = 4,200,000

Flotation costs on new issue: 3,000,000

Net after-tax cost to call the bonds: 6,200,000

B.

Old interest: $50,000,000(0.14)(0.6) = $4,200,000

New interest: $50,000,000(0.1167)(0.6) = (3,501,000)

Net annual interest savings $699,000

C.

Flotation costs benefit, new: ($3.00/25)(0.4) = $48,000

Flotation costs lost, old: ($3.00/30)(0.4) = (40,000)

Net annual amortization tax effects = $ 8,000

D.

Appropriate discount rate = New bond cost

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