Question

The State of Idaho issued $2,000,000 of 7% coupon, 20-year semiannual payment, tax-exempt bonds 5 years ago. The bonds had 5 years of call protection, but now the state can call the bonds if it chooses to do so. The call premium would be 5% of the face amount. Today 15-year, 5%, semiannual payment bonds can be sold at par, but flotation costs on this issue would be 2%. What is the net present value of the refunding? Because these are tax-exempt bonds, taxes are not relevant.

Answer 1

$278,606

Step-by-step explanation:

Calaculation of the net present value of the refunding:

The first step is to calculate call premium :

Call premium= 2,000,000 x 5%

= 100,000

Second step is to calculate the Flotation cost

Flotation cost = 2,000,000 x 2%

= 40,000

Calculation for Old interest = 2,000,000 x (7% / 2) = 70,000

Caluclatio fo New interest = 2,000,000 x (5% / 2) = 50,000

Therefore the Six months savings will be:

20,000 70,000 + 50,000 + 20,000 = 140,000

The PV of savings 30 periods 5% / 2 will be:

20,000 x 20.9303 = 418,606

Therefore the Net Present Value of the refunding will be:

418,606- 140,000

= $278,606