Morgan Corp.is refunding $6 million worth of 12% debt.The new bonds will be issued for 6%.The corporation's tax rate is 35%.The call premium is 8%.What is the net cost of the call premium?

Question

Quizplus · Accepted Answer

The first step is to calculate the gain on the early refunding:

Gain = $6,000,000 x (12% - 6%) = $360,000

Next, we need to calculate the cost of the call premium. The call premium is 8% of the face value of the bonds being refunded:

Call premium = $6,000,000 x 8% = $480,000

Finally, we need to calculate the net cost of the call premium by taking into account the tax savings resulting from the early refunding:

Tax savings = $360,000 x 35% = $126,000

Net cost of the call premium = $480,000 - $126,000 = $354,000, which is closest to choice B ($480,000).