GST Inc., is considering whether to refund a $50 million, 10.5 percent coupon, 30-year bond issue that was sold 5 years ago. It has been amortizing $3 million of flotation costs on the old bonds. GST's investment bankers have indicated that the company could sell a new 25-year issue at an interest rate of 9 percent in today's market. A call premium of 10.5 percent would be required to retire the old bonds, and flotation costs on the new issue would amount to $4 million. GST's marginal tax rate is 30 percent. The new bonds would be issued at the same time the old bonds were called. GST needs to issue new bonds one month prior to calling back the old bonds. It plans to invest the proceeds at 2.3% annual rate. Assume annual compounding for all calculations.
A) Should the old bond issue be refunded? Base your decision on the net present value of this analysis.
B) If the yield curve is upward sloping and the pure expectations theory is correct, would you refund now or wait? Explain.
C) Identify & explain one factor that has not been included in the above analysis but could impact your decision. (I would like you to do your best in answering this question without my help).
D) If the tax rates are expected to decrease in the future, would the NPV increase or decrease? Explain.
E) What is the appropriate discount rate to calculate the NPV of this decision? Explain (AT LEAST 2 REASONS)