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?
** Please see the attached file for the complete solution response **
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%
flotation costs $5,000,000
Time between issues (months) 1
rate on surplus funds ...
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