Reference no: EM133075018
One year ago BigBusiness, Inc., issued $100 million of 11-year bonds with a 9.5% coupon payable annually. The first coupon payment has just been paid. The bonds are callable at 105 beginning today. Floatation costs on that issue were $1 million. BigBusiness, Inc. has a 38% marginal tax rate.
Since interest rates have fallen, BigBusiness, Inc. is considering calling in the bonds and refinancing at current rates. It has the following ten-year financing alternative.
-A $100 million public issue of 8% annual coupon bonds. Flotation costs would be $1 million.
Note: Call premiums and interest payments are tax deductible. However, front-end fees and floatation costs must be capitalized and amortized over the life of the bond.
What is the effective, after-tax cost of leaving the existing bonds in place? In other words, what would be the after-tax all-in cost of refinancing that would make BigBusiness, Inc. indifferent between calling the bonds and leaving them in place?
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