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Problem:

Five years ago, NorthWest Water (NWW) issued $50,000,000 face value of 30-year bonds carrying a 14% (annual payment) coupon. NWW is now considering refunding these bonds. It has been amortizing $3 million of flotation 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 11.67% in today's market. A call premium of 14% would be required to retire the old bonds, and flotation costs on the new issue would amount to $3 million. NWW's marginal tax rate is 40%. The new bonds would be issued when the old bonds are called.

Required:

Question 1: What is the required after-tax refunding investment outlay, i.e., the cash outlay at the time of refunding?

Question 2: What will the after-tax annual interest savings for NWW be if the refunding takes place?

Note: Provide support for rationale.

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Accounting Basics, Accounting

Category:- Accounting Basics
Reference No.:- M91170949

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