ABC Ltd issued a Sh.100 million par value, 10-year 16% bond, five years ago. The bond was issued at a 2 per cent discount and issuing costs amounted to Sh.2 million. Due to the decline in Treasury bill rates in the recent past, interest rates in the money market have been falling presenting favourable opportunities for refinancing. A financial analyst engaged by the company to assess the possibility of refinancing the debt reports that a new Sh.100 million par value, 12 per cent, 5-year bond can be issued by the company. Issuing costs for the new bond will be 5 per cent of the par value and a discount of 3 per cent will have to be given to attract investors. The old bond can be redeemed at 10 per cent premium and in addition, two months interest penalty will have to be paid on redemption. All bond issue expenses (including the interest penalty) are amortised on a straight-line basis over the life of the bond and are allowable for corporate tax purposes.

The applicable corporate tax rate is 40 per cent and the after tax cost of debt to the company is approximately 7%.

Required:

a) Cash investment required for the refinancing decision.

b) Annual cash benefits (savings) of the refinancing decision.

c) i)   Net Present Value (NPV) of the refinancing decision.

    ii)   Is it worthwhile to issue a new bond to replace the existing bond? Explain.