XYZ Company is in awe at the recent change in interest rates. The current interest rate on A2 rated bonds is currently at 6 percent. The $30 million, 15-year bond issue that the company has outstanding was initially issued at 9 percent five years ago.
XYZ is considering refunding the bond issue due to this decline. The old issue had a call premium of 8 percent. The underwriting cost on the old issue had been 3 percent of par and on the new issue it would be 5 percent of par. The tax rate would be 30 percent and a 4 percent discount rate would be applied for the refunding decision. The new bond would have a 10-year life.
A. Compute the price of the old bonds in the open market using annual analysis. Determine the price for a single $1,000 par value bond.
B. Compare the price in part A to the 8 percent call premium over par value. Which appears to be more attractive in terms of reacquiring the old bonds?