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 10% 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. Should the bonds be refunded? Calculate the NPV of refunding.

Explanation / Answer

Here is how I understood it.

Amount: $50,000,000 Call premium %: 14%

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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