Response to the following problem:
The Pact Company is evaluating its outstanding bond issue in light of a recent drop in interest rates. Currently, it has $200 million of 8% coupon bonds (paid semiannually) outstanding that mature in five years and have a maturity value of $1,000 each. The bonds are callable at 106 at any time. Their outstanding bonds are priced to yield 6% on a bond-equivalent basis (i.e., a six-month yield of 3%) and the treasurer believes that if the bonds could retire the existing bonds, they could issue new bonds at par with a 6% coupon rate. Pact Company's marginal tax rate is 40%.
a. What is the total market value of the outstanding bonds?
b. Should Pact Company buy the outstanding bonds in the open market or call in the bonds at this point in time assuming no flotation costs for new bonds issued? Why?
c. If there are no flotation costs, what is the face value of new 6% bonds that must be issued to refund the existing bonds?
d. Should Pact refund the 8% bonds?