Bond Refunding - Strayer Education, Inc. As Brigham and Ehrhardt discuss in Financial Management, refunding bonds involves two decisions. The first focuses on profitability, "is it profitable to call an outstanding issue in the current period and replace it with a new issue?" The second decision looks at timeliness of the refunding related to the firm's value, "would the firm's expected value be increased even more if the refunding was postponed to a later date?" ((…showed first 75 words of 564 total…

…showed last 75 words of 564 total…premium-10% Flotation cost-5% Tax bracket40%40% EBIT24,285,00024,285,000 Key Points: Old IssueNew Issue Interest Paid$500,000$125,000 Lump Sums$500,000$625,000 * NPV$3,363,000$1,180,750 Taxes Paid$9,514,000$9,614,000 * $125,000 year 1 - $500,000 year 5 Old Issues: Cash Outlay $100,000 $100,000 $100,000 $100,000 $100,000 $100,000 $100,000$100,000 $100,000 100,000+ $500,000 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 "« Assume 1 million dollar bond "« 10% coupon rate for 10 years "« $100,000 paid annually (annuity) "« At 5 years bond is 50% or $500,000 "« Year 10, last annuity payment of $100,000 plus lump sum payment of $500,000 (50% of bond) Cash outflow AnnuityLump Sum 2003$100,000 2004$100,000 2005$100,000 2006$100,000 2007$100,000$500,000 Total$500,000$500,000 Key Points: "« Interest Paid = $500,000 "« Lump Sums = $500,000 "« NPV = $3,363,000 ($500,000 x 6.105 annuity = $3,052,500) ($500,000 x .621 lump sum = $310,500) ($3,052,500 + $310,500 = $3,363,000) "« Taxes = $9,514,000 ($24,285,000 - $500,000 interest paid = $23,785,000 x 40%)