Schooner Company is contemplating offering a new $50 million bond issue to replace an outstanding $50 million bond issue. The firm wishes to take advantage of the decline in interest rates that has occurred since the initial bond issuance. The old and new bonds are described in what follows. The firm is in the 40 percent tax bracket. Old bonds. The outstanding bonds have a $1,000 par value and a 9 percent coupon interest rate. They were issued five years ago with a twenty year maturity. They were initially sold for their par value of $1,000, and the firm incurred $350,000 in flotation costs. They are callable at $1,090. New bonds. The new bonds would have a $1,000 par value, a 7 percent coupon interest rate, and a fifteen-year maturity. They could be sold at their par value. The flotation cost of the new bonds would be $500,000. The firm does not expect to have any overlapping interest.
a. Calculate the tax savings that are expected from the unamortized portion or the old bonds' flotation cost.
b. Calculate the annual tax savings from the floatation cost of the new bonds, assuming the fifteen-year amortization.
c. Calculate the after-tax cost of the call premium that is required to retire the old bonds.
d. Determine the initial investment that is required to call the old bonds and issue the new bonds.
e. Calculate the annual cash flow savings, if any, that are expected from the proposed bond-refunding decision.
f. If the firm has a 4.2 percent after-tax cost of debt, find the net present value (NPV) of the bond-refunding decision. Would you recommend the proposed refunding? Explain your answer.