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Discussing Bond Refunding

Question: Margaret Kimberly, CFO of Charles River Associates, is considering whether or not to refinance the two currently outstanding corporate bonds of the firm. The first one is an 8 % perpetual bond with a $1000 face value with $75 million outstanding. The second one is a 9% perpetual bond with the same face value with $87.5 million outstanding. The call premiums for the two bonds are 8.5% and 9.5% of the face value, respectively. The transaction cost for refunding are $10 million and $12 million, respectively. The current interest rates for the two bonds are 7% and 7.25% respectively.

1. Which bond should Ms Kimberly recommend be refinanced?
2. What is the NPV of the refunding?

Solution Preview

Bond 1
Coupon rate 8%
Current rate 7%
Face value $1,000
Outstanding $75,000,000
Call premium 8.50%
Refunding costs $10,000,000

Bond 2
Coupon rate 9%
Current rate 7.25%
Face value $1,000
Outstanding $87,500,000
Call premium 9.50%
Refunding ...

Solution Summary

In about 155 words, this solution explains how to evaluate a bond refunding decision. All required calculations are included, along with accompanying explanations.

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