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A firm is considering the refunding of an outstanding 30-year bond issue. The original issue consists of $20 million in 12% callable bonds with $300,000 in flotation costs and a call premium of 10%.
The firm can replace the old bonds now (10 years after the original issue date) with a new 20-year issue consisting of $20 million in 11% bonds with $450,000 in flotation costs.
The new funds will be received two months before the funds are disbursed for the old bonds. Short-term treasury bills are priced to yield 6% currently. Finally, the firm's total tax rate is 40%.
Question 1: What is the net present value of bond refunding?
a. 3,056,440
b. - 1,690,000
c. 1,690,000
d. - 323,560
e. 323,560
Question 2: Given your answer to question above, should the firm refund? Why or why not?
a. No because NPV < 0
b. Yes because NPV < 0
c. No because NPV > 0
d. Yes because NPV > 0
e. In fact, none of the answers is correct