The Bowman Corporation has a $20 million bond obligation outstanding, which it is considering refunding. Though the bonds were initially issued at 12 percent,
the interest rates on similar issues have declined to 10.5 percent. The bonds were originally issued for 20 years and have 15 years remaining. The new issue
would be for 15 years. There is an 8 percent call premium on the old issue. The underwriting cost on the new $20 million issue is $570,000, and the
underwriting cost on the old issue was $400,000. The company is in a 35 percent tax bracket, and it will use a 7 percent discount rate (rounded after-tax cost
of debt) to analyze the refunding decision.
Should the old issue be refunded with new debt?
SolutionProblem 16-17Instructions
Use formulas and functions to complete the requirements of this problem.
Information
Bond obligation_________________$20,000,000
Interest rate on bonds____________12%
Interest rate on new bonds________10.5%
Call premium___________________8%
Tax rate_______________________35%
Underwriting costs of new issue____$570,000
Underwriting costs of old issue_____$400,000
Years remaining on bonds________15
Discount rate___________________7%