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Bond Refunding Analysis for Mullet Technologies

Mullet Technologies is considering whether or not to refund a $75 million, 12% coupon, 30-year bond issue that was sold 5 years ago. It is amortizing $5 million of flotation costs on the 12% bonds over the issue's 30-year life. Muttlet's investment banks have indicated that the company could sell a new 25-year issue at an interest rate of 10% in today's market. Neither they nor Mullet's management anticipate that interest rates will fall below 10% any time soon, but there is a chance that rates will increase.

A call premium of 12% would be required to retire the old bonds, and flotation costs on the new issue would amount to $5 million. Mullet's marginal federal-plus-state tax rate is 40%. The new bonds would be issued 1 month before the old bonds are called, with the proceeds being invested in short-term government securities returning 6% annually during the interim period.

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

b. What factors would influence Mullet's decision to refund now rather than later?

Solution Preview

** Please see the attached file for the complete solution response **

Legend
Computation
Current bond issue information
Par value $75,000,000
coupon rate 12%
original maturity 30
remaining maturity 25
original flotation costs $5,000,000
Call premium 12%
Tax rate 40%

New issue information
Coupon rate 10.0000%
maturity 25
flotation costs $5,000,000

Time between issues (months) 1
rate on surplus funds ...

Solution Summary

This solution provides a detailed, step by step calculation of the given finance problem.

$2.19