Wood River Power Company is considering refunding a $100 million 12% coupon debenture issue with a 9% coupon, 20-year debenture. The 12% issue also matures in 20 years and is now callable at 109% of par. The unamortized flotation cost on the old issue is $360,000 and the flotation cost of the new issue is 0.775%. Wood River estimated that there would be a 4 week period where both bonds would be outstanding. The company has a weighted cost of capital of 11% and a 40% marginal tax rate. Should Wood River sell the refunding issue? (Note: PVIFA_0.054,20= 12.050) A) yes, NPV is approximately $15.21 million B) yes, NPV is approximately $9.86 C) yes, NPV is approximately 6.485 million D) No, NPV is negative $0.554 million

Question

Quizplus · Accepted Answer

Solution:
Interest saved = $100(0.03)(0.6) = $1.8 million per year
PV interest saved = $1.8(12.050) = $21.69 million
A.T. call premium = $100(0.09)(0.6) = $5.4 million
PV flotation cost = $100(0.00775) - ($0.775/20)(0.4)(12.050) = $0.588 million
PV flotation, old issue = ($0.360/20)(0.4)12.050 - $0.360(0.4) = $0.0572 million
Overlapping interest after-tax = $100(0.072)(4/52) = $0.554 million
Net investment = $5.4 + $0.588 - $0.0572 + $0.554 = $6.485 million
NPV of refunding = $21.69 - $6.485 = $15.21 million

Wood River Power Company Is Considering Refunding a $100 Million