Question: The Sunbelt Corporation has 40 million of bonds outstanding that
The Sunbelt Corporation has $40 million of bonds outstanding that were issued at a coupon rate of 12⅞ percent seven years ago. Interest rates have fallen to 12 percent. Mr. Heath, the vice-president of finance, does not expect rates to fall any further. The bonds have 18 years left to maturity, and Mr. Heath would like to refund the bonds with a new issue of equal amount also having 18 years to maturity. The Sunbelt Corporation has a tax rate of 36 percent. The underwriting cost on the old issue was 2.5 percent of the total bond value. The underwriting cost on the new issue will be 1.8 percent of the total bond value. The original bond indenture contained a five-year protection against a call, with an 8 percent call premium starting in the sixth year and scheduled to decline by one-half percent each year thereafter (consider the bond to be seven years old for purposes of computing the premium). Assume the discount rate is equal to the aftertax cost of new debt rounded up to the nearest whole number. Should the Sunbelt Corporation refund the old issue?
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