Question

Question: The Bowman Corporation has a \(18 million bond obligation outstanding, which it is considering refunding. Though the bonds were initially issued at 10 percent, the interest rates on similar issues have declined to 8.5 percent. The bonds were originally issued for 20 years and have 10 years remaining. The new issue would be for 10 years. There is a 9 percent call premium on the old issue. The underwriting cost on the new \)18,000,000 issue is \(530,000, and the underwriting cost on the old issue was \)380,000. The company is in a 35 percent tax bracket, and it will use an 8 percent discount rate (rounded after-tax cost of debt) to analyze the refunding decision.

d. Should the old issue be refunded with new debt?

Short answer

The company should refund the old issue with new bonds as the bond interest rates have declined from 10% to 8.5%.

Step-by-step solution

Meaning of refunded bond

The process of issuing new bonds for the purpose of repaying the matured bonds is called refunding. The bonds issued for raising funds for retiring old bonds are called refunded bonds.

Explanation for refunding the bonds

The company should refund the old bonds with new debt. The interest rates of bonds have declined from 10% to 8.5% and the company will be able to generate interest savings and increase its income by refunding the bonds.