Schumann Shoe Manufacturer is considering whether or not to refu

Schumann Shoe Manufacturer is considering whether or not to refund a $70 million, 10% coupon, 30-year bond issue that was sold 8 years ago. It is amortizing $4.5 million of flotation costs on the 10% bonds over the issue's 30-year life. Schumann's investment bankers have indicated that the company could sell a new 22-year issue at an interest rate of 8 percent in today's market. Neither they nor Schumann's management anticipate that interest rates will fall below 6 percent any time soon, but there is a chance that interest rates will increase.

A call premium of 10 percent would be required to retire the old bonds, and flotation costs on the new issue would amount to $5 million. Schumann's marginal federal-plus-state tax rate is 40 percent. The new bonds would be issued 1 month before the old bonds are called, with the proceeds being invested in short-term government securities returning5 percent annually during the interim period.

Current bond issue data

Par value .....................................................................$70,000,000

Coupon rate.............................................................................10%

Original maturity ........................................................................30

Remaining maturity ....................................................................22

Original flotation costs .................................................$4,500,000

Call premium ...........................................................................10%

Tax rate ....................................................................................40%

Refunding data

Coupon rate ......................................................................8.0000%

Maturity .....................................................................................22

Flotation costs .............................................................$5,000,000

Before Tax

70,000,000 x.10=7,000,000

After Tax

70,000,000 x 1-T

Time between issuing new bonds and calling old bonds (months) 1

Rate earned on proceeds of new bonds before calling old bonds (annual) 5%


a. Perform a complete bond refunding analysis. What is the bond refunding NPV?

b. At what interest rate on the new debt is the NPV of the refunding no longer positive?


Maturity
Maturity is the date on which the life of a transaction or financial instrument ends, after which it must either be renewed, or it will cease to exist. The term is commonly used for deposits, foreign exchange spot, and forward transactions, interest...