The Robinson Corporation has $50 million of bonds outstanding which were issued at a coupon rate of 11 3/4 percent seven years ago. Interest rates have fallen to 10 3/4 percent. Mr. Brooks, the vice-president of finance, does not expect rates to fall any further. The bonds have 18 years left to maturity, and Brooks would like to refund the bonds with a new issue of equal amount also having 18 years to maturity. The Robinson Corporation has a tax rate of 35 percent. The underwriting cost on the old issue was 2.5 percent of the total bond value. The underwriting cost on the new issue will be 1.8 percent of the total bond value. The original bond indenture contained a five-year protection against a call, with a 9.5 percent call premium starting in the sixth year and scheduled to decline b one-half percent each year thereafter. (Consider the bond to be seven years old for purposes of computing the premium.) Assume the discount rate is equal to the aftertax cost of new debt rounded to the nearest whole number. Should the Robinson Corporation refund the old issue?
Study problem 18 starting on page 520. Given a 7% discount rate, find out the cost savings from lower interest rates Robinson would realize if Robinson refinanced its long term debt. Show work and describe.(Note: just find out the cost savings from lower interest rates only, don't solve the whole problem.)