Oxford Corp. is considering refunding a $30,000,000, annual payment, 12 percent

Question

Oxford Corp. is considering refunding a $30,000,000, annual payment, 12 percent coupon, 30-year bond issue that was issued five years ago. It has been amortizing $2 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 percent in today's market. A call premium of 12 percent would be required to retire the old bonds, and flotation costs on the new issue would amount to $2 million. Oxford's marginal tax rate is 30 percent. The new bonds would be issued when the old bonds are called.

What is the required after-tax refunding investment outlay, i.e., the cash outlay at the time of the refunding?

Explanation / Answer

Cost of refunding:

Call Premium = 12/100 * ($30 million) = 3,600,000 ;

Floatation cost =2,000,000 ;

Total investment outlay = 5,600,000;

Interest on old bond = 0.12*($30 million) = 3,600,000 ;

Interest on new bond = 0.1*($30 million) = 3,000,000;

Savings =600,000 ;

PV of savings, 25 periods at 10% = 5,446,224

NPV of refunding = PV of savings - cost of refunding = -153,776

ans is -153,776

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