ABC WasteABC Waste (ABCW) is considering refunding a $50,000,000, annual payment, 14% coupon, 30-year bond issue that was issued 5 years ago. It has been amortizing $3 million of flotation costs on these bonds over their 30-year life. The company could sell a new issue of 25-year bonds at an annual interest rate of 11.67% in today's market. A call premium of 8.4% would be required to retire the old bonds, and flotation costs on the new issue would amount to $3 million. ABCW's marginal tax rate is 40%. The new bonds would be issued when the old bonds are called.
-Refer to Scenario: ABC Waste.What is the NPV if ABCW refunds its bonds today?
A)$1,746,987
B)$1,838,933
C)$1,935,719
D)$2,037,599

Question

Quizplus · Accepted Answer

To calculate the NPV of refunding the bonds, we need to calculate the cash flows of both the old and the new bond issue.

Cash flows from the old bond issue:
- Call premium: $50,000,000 x 8.4% = $4,200,000
- Flotation costs: $3,000,000 - $2,000,000 (amortized) = $1,000,000

Therefore, the cash outflow for redeeming the old bonds is: $50,000,000 + $4,200,000 + $1,000,000 = $55,200,000

Cash flows from the new bond issue:
- Issue size: $50,000,000
- Interest rate: 11.67%
- Flotation costs: $3,000,000

Then, we can calculate the present value of both the old and the new bond issue using the given interest rate of 11.67% and ABCW's marginal tax rate of 40%.

PV of cash outflows:
$55,200,000/(1-0.4) = $92,000,000

PV of cash inflows:
-$50,000,000 + ($3,000,000/(1-0.4)) + ($50,000,000 x (1-0.084))/((1-0.4)/25) - $3,000,000/((1-0.4)/25) = -$94,037,599

Finally, we can calculate the NPV:

NPV = PV of cash inflows - PV of cash outflows = $94,037,599 - $92,000,000 = $2,037,599

Therefore, the NPV of refunding the bonds today is $2,037,599. Thus, the best choice is D, refund the bonds today.

ABC WasteABC Waste (ABCW) Is Considering Refunding a $50,000,000, Annual