Q. Thompson Enterprises has $5,000,000 of bonds outstanding. Each bond has a maturity value of $1,000, an annual coupon of 12.0% and 15 years left to maturity. The bonds can be called at any time with a premium of $50 per bond. If the bonds are called, the industry must pay flotation costs of $10 per new refunding bond. Ignore tax considerations--assume that the company's tax rate is zero.

The industry's decision of whether to call the bonds depends critically on the present interest rate on newly issued bonds. Illustrate what is the breakeven interest rate, the rate below which it would be profitable to call in the bonds?

Rainier Bros. has 12.0% semi-annual coupon bonds outstanding that mature in 10 years. Each bond is now eligible to be called at a call price of $1,060. If the bonds are called, the industry must replace them with new 10-year bonds. The flotation cost of issuing new bonds is estimated to be $45 per bond. Explain how low would the yield to maturity on the new bonds have to be in order for it to be profitable to call the bonds today, i.e., illustrate what is the nominal annual "breakeven rate"?