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Refunding Analysis
Five years ago, Northwest Water (NWW) issued $40,000,000 face value of 30-year bonds carrying an 8% (annual payment) coupon. NWW is now considering refunding these bonds. It has been amortizing $4 million of floatation costs on these bonds over their 30-year life. The company could sell a new issue of 25-year bonds at an annual interest rate of 6% in today’s market. A call premium of 5% would be required to retire the old bonds, and flotation costs on the new issue would amount for $3 million. NWW’s marginal tax rate is 40%. The new bonds would be issued when the old bonds are called.
a) What is the required after-tax refunding investment outlay, i.e., the cash outlay at the time of the refunding?
b) What will the after-tax annual interest savings for NWW be if the refunding takes place?
c) The amortization of floatation costs reduces taxes and thus provides an annual cash flow. What will the net increase or decrease in the annual flotation cost tax savings be if refunding takes place?
d) What is the NPV if NWW refunds its bonds today?
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