1 answer

OTOnits 10, 10 years ago, the City ofMelrose issued $4,000,000 of9% coupon, 15-year, annual payment, tax-exempt...

Question:

OTOnits 10, 10 years ago, the City ofMelrose issued $4,000,000 of9% coupon, 15-year, annual payment, tax-exempt muni bonds. The bonds had 10 years of call protection, but now the bonds can be called if the city chooses to do so. The call premium would be 5% of the face amount. New 5-year, 7%, annual payment bonds can be sold at par, but flotation costs on this issue would be 3% of the amount of bonds sold. What is the net present value of the refunding? Note that cities pay no income taxes, hence taxes are not relevant.
OTOnits 10, 10 years ago, the City ofMelrose issued $4,000,000 of9% coupon, 15-year, annual payment, tax-exempt muni bonds. The bonds had 10 years of call protection, but now the bonds can be called if the city chooses to do so. The call premium would be 5% of the face amount. New 5-year, 7%, annual payment bonds can be sold at par, but flotation costs on this issue would be 3% of the amount of bonds sold. What is the net present value of the refunding? Note that cities pay no income taxes, hence taxes are not relevant.

Answers

Current Annual coupons = 4,000,000 x 9% = 360,000

New annual coupon if bonds are refunded = 4,000,000 x 7% = 280,000

Annual saving = 80,000

Now in order to saving that, upfront cost include

Call premium = 5% x 4,000,000 = 200,000

Floating cost = 4,000,000 x 3% = 120,000

Let's calculate present value of annual saving using PV function

N = 5, PMT = 80,000, FV = 0, I/Y = 7%

=> Compute PV = $328,015.79

NPV = 328,015.79 - 120,000 - 200,000 = $8,015.79

.

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