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Homework answers / question archive / The State of Florida issued $1,000,000 of 12 percent coupon
The State of Florida issued $1,000,000 of 12 percent coupon. 10-year annual payment, tax-exempt bonds 5 years ago. The bond had 5 years of call protection, but now the state can call the bond if its chooses to do so. The call premium would be 2 percent of the face amount. The 5-year, 10 percent, annual payment bond can be sold at par, but flotation costs on this issue would be 4 percent, or $40,000. What is the net present value of the refunding?
A. $100,000
B. $15,816
C. $40,000
D. $26,449
E. -$44,449
please see the attached file.for the complet solution.
There are inflows and outflows with bond refunding. The outflows are the call premium and the bond issue and the inflows are the savings in interest.
Outflows
Call Premium (1,000,000X2%) 20,000
Bond Issue Costs 40,000
Total Outflow 60,000
Inflow is the reduction in interest. The interest rate will reduce from 12% to 10% or 2%. Every year there will be savings in interest of 2% X 1,000,000=20,000. We need to find the PV of the savings to compare with the PV of the outflows. This amount is an annuity so the PV is
20,000 X PVIFA (5, 10%). Using the PVIFA table, the factor is 3.791. The PV of interest savings is 20,000X3.79079=75,816. The NPV of the bond refunding is
Inflows - Outflow
=75,816-60,000=$15,816
