10 years ago, the City of Melrose issued $3,000,000 of 8% coupon, 30-year, semiannual payment, tax-exempt muni bonds.The bonds had 10 years of call protection, but now the bonds can be called if the city chooses to do so.The call premium would be 6% of the face amount.New 20-year, 6%, semiannual payment bonds can be sold at par, but flotation costs on this issue would be 2% of the amount of bonds sold.What is the net present value of the refunding? Note that cities pay no income taxes, hence taxes are not relevant.

Question

Quizplus · Accepted Answer

The net present value of the refunding is the present value of the savings in interest payments minus the present value of the call premium and flotation costs. The savings in interest payments is the difference between the interest payments on the old bonds and the interest payments on the new bonds. The call premium is the amount of money that the city would have to pay to call the old bonds. The flotation costs are the costs of issuing the new bonds.The present value of the savings in interest payments is:PV = $3,000,000 * (0.08 - 0.06) * 20 * 0.5 / (1 + 0.03)^1= $3,000,000 * 0.02 * 20 * 0.5 / 1.03= $582,235The present value of the call premium is:PV = $3,000,000 * 0.06 / (1 + 0.03)^1= $3,000,000 * 0.06 / 1.03= $179,610The present value of the flotation costs is:PV = $3,000,000 * 0.02 / (1 + 0.03)^1= $3,000,000 * 0.02 / 1.03= $58,224The net present value of the refunding is:NPV = $582,235 - $179,610 - $58,224= $344,401Therefore, the net present value of the refunding is $344,401.

10 Years Ago, the City of Melrose Issued $3,000,000 of 8