Daedulus Wings has had several successful years in the airline business and had received recognition from many quarters for flying higher, further, and cheaper than the competition. Its financial state of affairs has not been as successful. The new vice-president of finance is reviewing some debentures that carry fairly high semiannual payments.
The vice-president notes in particular a bond issue that was issued 8 years ago with 15 years to maturity at an annual rate of 12 percent, payable semiannually. It has a call provision at a premium of 8 percent above par value. The bond issue has $50 million outstanding.
Current long-term interest rates are 7.5 percent, payable on a semiannual basis and short-term rates are 3 percent. If the old bonds are called, the vice-president will require a 15-day overlap period. Wings has a tax rate of 35 percent. Underwriting and other financing expenses will be $1 million. Should the old issue be refunded and replaced with a debt issue with a comparable maturity? Show your calculations.