New Jersey Waster Co. (NJWC) is considering whether to refund a $50 million, 14
ID: 2713122 • Letter: N
Question
New Jersey Waster Co. (NJWC) is considering whether to refund a $50 million, 14 percent coupon, 30-year bond issue that was sold 5 years ago. It is amortizing $3 million of flotation costs on the 14 percent bonds over the 30-year life of that issue. NJWC’s investment bankers have indicated that the company could sell a new 25-year issue at an interest rate of 11.67 percent in today’s market. A call premium of 14 percent would be required to retire the old bond, and floatation costs on the new issue would amount to $3 million. NJWC’s marginal tax rate is 40 percent. The new bonds would be issued at the same time the old bonds were called.
What is the relevant refunding investment outlay?
What are the relevant annual interest savings for NJWC if refunding takes place?
What are the relevant annual flotation cost tax effects for NJWC if refunding takes place.
What is the NJWC bond refunding’s NPV?
Show work please
Explanation / Answer
Solution :
Current bond issue information
Par value
50000000
coupon rate
14%
original maturity
30
remaining maturity
25
original flotation costs
3000000
Call premium
14%
Tax rate
40%
New issue information
Coupon rate
11.6700%
Maturity
25
flotation costs
3000000
Calculation of refunding investment outlay :
Initial investment outlay to refund old issue:
Call premium on old issue = (50000000 x 14%)
7000000
After-tax call premium = 7000000x (1-0.40)
4200000
New flotation cost =
3000000
Old flotation costs already expensed = (3000000*5/30)
500000
Remaining flotation costs to expense =(30lac - 5 lac)
2500000
Tax savings from old flotation costs = (25 lac x 40%)
1000000
Total investment outlay = (42lac + 30 lac -10 lac)
6200000
Annual interest savings due to refunding:
Annual after tax interest on old bond = 500lac x 14% x (1-40%)
4200000
Annual after tax interest on new bond = 500 lac x 11.67% x (1-0.40)
3501000
Net after tax interest savings = (42 lac - 35.01 lac)
699000
Annual Flotation Cost Tax Effects:
Annual tax savings on new flotation = (30 lac x 40%/25)
48000
Tax savings lost on old flotation = (30 lac x 40% /30)
40000
Total amortization tax effects = (48000-40000)
8000
Annual cash flows = (8000 + 699000)
707000
NPV of refunding decision =
-525381.33
pv of inflow - pv of outflow
(707000 x 8.0263 ) - 6200000
as discount rate is not given it is assumed to be same as new bond interest rate of 11.67%
Current bond issue information
Par value
50000000
coupon rate
14%
original maturity
30
remaining maturity
25
original flotation costs
3000000
Call premium
14%
Tax rate
40%
New issue information
Coupon rate
11.6700%
Maturity
25
flotation costs
3000000
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