Rainier Bros. has 12.0% semiannual coupon bonds outstanding that mature in 10 years. Each bond is now eligible to be called at a call price of $1,060. If the bonds are called, the company must replace them with new 10-year bonds. The flotation cost of issuing new bonds is estimated to be $45 per bond. How low would the yield to maturity on the new bonds have to be in order for it to be profitable to call the bonds today, i.e., what is the nominal annual "breakeven rate"?

Question

Quizplus · Accepted Answer

The breakeven rate is calculated by considering the call price, flotation costs, and the coupon rate of the existing bonds. The yield to maturity on the new bonds must be lower than the effective cost of the existing bonds, which includes the call price and flotation costs.