Question

I Charles River Associates is considering whether to call either of the two perpetual bond s the company currently has outstanding. If the bond is called, it will be refunded. that is a new bond issue will be made with a lower coupon rate. The proceeds from the new bond issue will be used to repurchase one of the existing bond issues. The information about the two currently outstanding bond issues is: Bond A Coupon rate Value outstanding $132,000,000 Call premium 74% Transaction cost of $ 12.200.000 refunding Current YTM 6.25% Bond B 8% $139,000,000 81% $16,500,000 71% The corporate tax rate is 40 percent What is the NPV of the refunding for each bond? (Do not round intermediate calculations and round your final answers to 2 decimal places. (e.g.. 32.16)) NPV Bond A Bond B Which, if either, bond should the company refinance? Bond A Bond B Refund both bonds

the last option is "Neither bond"

Answer 1

Sl. No	Parameters & Calculation	Bond A	Bond B
1	Coupon Rate (CR)	7%	8%
2	Value Outstanding (VO)	132,000,000.00	139,000,000.00
3	Call Premium (CP)	7.40%	8.10%
4	Transaction cost of refunding (TC)	12,200,000.00	16,500,000.00
5	Current YTM (YTM)	6.25%	7.10%
6	Corporate Tax Rate (T)	40%	40%
7	Bond Interest (I = CR*VO)	9,240,000.00	11,120,000.00
8	Bond Value (BV) = [{I/(1+YTM)}+{VO/(1+YTM)}]	132,931,764.71	140,168,067.23
9	Cost of Buy back (CB) = [(VO*CP) + TC]	21,968,000.00	27,759,000.00
10	Cas Flow from Refunding Operation (CF) = (BV - CB)	110,963,764.71	112,409,067.23
11	Cash Flow after Tax	66,578,258.82	67,445,440.34
12	NPV	62,661,890.66	62,974,267.35

	NPV
Bond A	$ 62,661,890.66
Bond B	$ 62,974,267.35

Since Bond B has higher NPV, hence the company should refinance Bond B.