Assume the discount rate is equal to theaftertax cost of


The Sunbelt Corp. has $40 million of bonds outstanding thatwere issued at a coupon rate of 12 7/8 percent seven yearsago. Interest rates have fallen to 12 percent. Mr.Heath does not expect the rates to fall any further. Thebonds have 18 years left to maturity, and Mr. Heath would like torefund the bonds with a new issue of equal amount also having 18years to maturity. The Sunbelt Corp. has a tax rate of 36percent. The underwriting cost on the old issue was 2.5percent of the total bond value. The underwriting cost on thenew issue will be 1.8 percent of the total bond value. Theoriginal bond indenture contained a five-year proctection against acall, with an 8 percent call premium starting in the sixth year andscheduled to decline by one-half percent each year thereafter(consider the bond to be seven years old for purposes of computingthe premium). Assume the discount rate is equal to theaftertax cost of new debt rounded up to the nearest wholenumber. Should Sunbelt Corp. refund the old issue?

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Finance Basics: Assume the discount rate is equal to theaftertax cost of
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