NARRBEGIN: Loose Cannon refunding
Loose Cannon Co.
Loose Cannon Co.is evaluating a new $75 million bond issue,the proceeds of which would be used to call and retire its outstanding $75 million bonds.Details on both bond issues are presented below.The firm is in the 35% tax bracket.
Old Bonds The old issue sold at par,with a coupon rate of 11 percent.It was issued five years ago with a twenty year maturity.The issue had $350,000 in flotation costs and carries a call price of $1150.
New Bonds The new issue are expected to sell at par with an 8.5 percent coupon rate and a 15 year maturity.Flotation costs are forecast to be $500,000.Interest payments will overlap for 2 months while the old bonds are retired.
-Refer to Loose Cannon Co.What is the NPV of the refunding decision?

Question

Quizplus · Accepted Answer

The NPV of the refunding decision is calculated by considering the savings from the lower interest payments on the new bonds, minus the costs associated with retiring the old bonds (including the call premium and flotation costs for the new bonds), and adjusting for the tax shield on the interest savings. The correct choice reflects the calculation that accounts for these factors accurately.

NARRBEGIN: Loose Cannon Refunding