Problem
DPS is considering whether to refund an issue of 10,000 bonds that were issued with a $1,000 par value, five years ago for a 5.75% coupon rate with a 15 year term-to-maturity. DPS is amortizing $250,000 of flotation costs over the life of the old issue. DPS's investment bankers have indicated that the company could sell a new 10-year issue at a yield of 4.25% percent in today's market (10,000 bonds with a $1,000 face value). A call premium of 10 percent would be required to retire the old bonds, and flotation costs on the new issue would amount to $200,000. DPS's marginal tax rate is 34 percent. The new issue would also be callable and have a call premium of 10%. Assume that the old bonds are retired as soon as the new bonds are sold (no bridge period). What is the NPV of the proposed refunding? Should DPS refund the old issue?