Problem 15-10 Bond Refunding

Charles River Associates is considering whether to call either of the two perpetual bond issues 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				Bond B
Coupon rate		7	%			8	%
Value outstanding	$	137,000,000			$	144,000,000
Call premium		7.6	%			8.6	%
Transaction cost of refunding	$	12,700,000			$	19,000,000
Current YTM		6.25	%			7.0	%

The corporate tax rate is 35 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

Neither bond

Problem 15-8 Valuing Callable Bonds

Illinois Industries has decided to borrow money by issuing perpetual bonds with a coupon rate of 8.0 percent, payable annually. The one-year interest rate is 8.0 percent. Next year, there is a 35 percent probability that interest rates will increase to 10 percent, and there is a 65 percent probability that they will fall to 6 percent.

a.	What will the market value of these bonds be if they are noncallable? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Market value

$

b.

If the company decides instead to make the bonds callable in one year, what coupon rate will be demanded by the bondholders for the bonds to sell at par? Assume that the bonds will be called if interest rates fall and that the call premium is equal to the annual coupon. (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Coupon rate

%

c.	What will be the value of the call provision to the company? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Value of the call provision

$