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Exam 16: Bond Refunding

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Question 1

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NorthWest Water (NWW) Five years ago, NorthWest Water (NWW) issued $50,000,000 face value of 30-year bonds carrying a 14% (annual payment) coupon. NWW is now considering refunding these bonds. It has been amortizing $3 million of flotation costs on these bonds over their 30-year life. The company could sell a new issue of 25-year bonds at an annual interest rate of 11.67% in today's market. A call premium of 14% would be required to retire the old bonds, and flotation costs on the new issue would amount to $3 million. NWW's marginal tax rate is 40%. The new bonds would be issued when the old bonds are called. -Refer to the data for NorthWest Water (NWW) .What will the after-tax annual interest savings for NWW be if the refunding takes place?

A) $664,050
B) $699,000
C) $768,900
D) $845,790
E) $930,369

F) C) and E)
G) A) and E)

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Question 2

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NorthWest Water (NWW) Five years ago, NorthWest Water (NWW) issued $50,000,000 face value of 30-year bonds carrying a 14% (annual payment) coupon. NWW is now considering refunding these bonds. It has been amortizing $3 million of flotation costs on these bonds over their 30-year life. The company could sell a new issue of 25-year bonds at an annual interest rate of 11.67% in today's market. A call premium of 14% would be required to retire the old bonds, and flotation costs on the new issue would amount to $3 million. NWW's marginal tax rate is 40%. The new bonds would be issued when the old bonds are called. -Refer to the data for NorthWest Water (NWW) .The amortization of flotation costs reduces taxes and thus provides an annual cash flow.What will the net increase or decrease in the annual flotation cost tax savings be if refunding takes place?

A) $6,480
B) $7,200
C) $8,000
D) $8,800
E) $9,680

F) B) and E)
G) B) and C)

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Question 3

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NorthWest Water (NWW) Five years ago, NorthWest Water (NWW) issued $50,000,000 face value of 30-year bonds carrying a 14% (annual payment) coupon. NWW is now considering refunding these bonds. It has been amortizing $3 million of flotation costs on these bonds over their 30-year life. The company could sell a new issue of 25-year bonds at an annual interest rate of 11.67% in today's market. A call premium of 14% would be required to retire the old bonds, and flotation costs on the new issue would amount to $3 million. NWW's marginal tax rate is 40%. The new bonds would be issued when the old bonds are called. -Refer to the data for NorthWest Water (NWW) .What is the NPV if NWW refunds its bonds today?

Which of the following factors would increase the likelihood that a company would call its outstanding bonds at this time?

NorthWest Water (NWW) Five years ago, NorthWest Water (NWW) issued $50,000,000 face value of 30-year bonds carrying a 14% (annual payment) coupon. NWW is now considering refunding these bonds. It has been amortizing $3 million of flotation costs on these bonds over their 30-year life. The company could sell a new issue of 25-year bonds at an annual interest rate of 11.67% in today's market. A call premium of 14% would be required to retire the old bonds, and flotation costs on the new issue would amount to $3 million. NWW's marginal tax rate is 40%. The new bonds would be issued when the old bonds are called. -Refer to the data for NorthWest Water (NWW) .What is the required after-tax refunding investment outlay, i.e., the cash outlay at the time of the refunding?

Palmer Company has $5,000,000 of 15-year maturity bonds outstanding.Each bond has a maturity value of $1,000, an annual coupon of 12.0%.The bonds can be called at any time with a premium of $50 per bond.If the bonds are called, the company must pay flotation costs of $10 per new refunding bond.Ignore tax considerations⎯assume that the firm's tax rate is zero. The company's decision of whether to call the bonds depends critically on the current interest rate on newly issued bonds.What is the breakeven interest rate, the rate below which it would be profitable to call in the bonds?

Suppose a company issued 30-year bonds 4 years ago, when the yield curve was inverted.Since then long-term rates (10 years or longer) have remained constant, but the yield curve has resumed its normal upward slope.Under such conditions, a bond refunding would almost certainly be profitable.

The appropriate discount rate to use when analyzing a refunding decision is the after-tax cost of new debt, in part because there is relatively little risk of not realizing the interest savings.

10 years ago, the City of Melrose issued $3,000,000 of 8% coupon, 30-year, semiannual payment, tax-exempt muni bonds.The bonds had 10 years of call protection, but now the bonds can be called if the city chooses to do so.The call premium would be 6% of the face amount.New 20-year, 6%, semiannual payment bonds can be sold at par, but flotation costs on this issue would be 2% of the amount of bonds sold.What is the net present value of the refunding? Note that cities pay no income taxes, hence taxes are not relevant.

Which of the following statements is most CORRECT?

Stanovich Enterprises has 10-year, 12.0% semiannual coupon bonds outstanding.Each bond is now eligible to be called at a call price of $1,060.If the bonds are called, the company must replace them with new 10-year bonds.The flotation cost of issuing new bonds is estimated to be $45 per bond.How low would the yield to maturity on the new bonds have to be in order for it to be profitable to call the bonds today, i.e., what is the nominal annual "breakeven rate"?

Five years ago, the State of Oklahoma issued $2,000,000 of 7% coupon, 20-year semiannual payment, tax-exempt bonds.The bonds had 5 years of call protection, but now the state can call the bonds if it chooses to do so.The call premium would be 5% of the face amount.Today 15-year, 5%, semiannual payment bonds can be sold at par, but flotation costs on this issue would be 2%.What is the net present value of the refunding? Because these are tax-exempt bonds, taxes are not relevant.

When a firm refunds a debt issue, the firm's stockholders gain and its bondholders lose.This points out the risk of a call provision to bondholders and explains why a non-callable bond will typically command a higher price than an otherwise similar callable bond.

If the firm uses the after-tax cost of new debt as the discount rate when analyzing a refunding decision, and if the NPV of refunding is positive, then the value of the firm will be maximized if it immediately calls the outstanding debt and replaces it with an issue that has a lower coupon rate.