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Refund the old issue of bonds outstanding

The Robinson Corporation has $50 million of bonds outstanding that were issued at a coupon rate of 11 3/4 percent seven years ago. Interest rates have fallen to 10 3/4 percent. Mr. Brooks, the vice-president of finance, does not expect rates to fall any further. The bonds have 18 years left to maturity, and Mr. Brooks would like to refund the bonds with a new issue of equal amount also having 18 years of to maturity. The Robinson Corporation has a tax rate of 35 percent. The underwriting cost on the old issue was 2.5 percent of the total bond value. The underwriting cost on the new issue will be 1.8 percent of the total bond value. The original bond indenture contained a five-year protection against a call, with a 9.5 percent call premium starting in the sixth year and scheduled to decline by one-half percent each year thereafter. (Consider the bond to be seven years old for purposes of computing the premium.) Assume the discount rate is equal to the after tax cost of new debt rounded up to the nearest whole number. Should the Robinson Corporation refund the old issue?

Solution Summary

This solution explains whether or not the Robinson Corporation should refund an old issue given information such as coupon rates, interest rates, underwriting cost and original bond indenture.

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