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Input Data
Existing bond issue
Original flotation cost
Maturity of original debt
Years since old debt issue
Call premium (%)
Original coupon rate
After-tax cost of new debt

$75,000,000
$5,000,000
30
5
12.0%
12.0%
5.4%

New bond issue

New flotation cost
New bond maturity
New cost of debt

$75,000,000
$5,000,000
25
9.0%

Tax rate
Short-term interest rate

40.0%
6.0%

Schedule of cash flows

Investment Outlay
Call premium on the old bond
Flotation costs on new issue
Immediate tax savings on old flotation cost expense
Extra interest paid on old issue
Interest earned on short-term investment

Before-tax
($9,000,000.0)
($5,000,000.0)
$4,166,666.7
($750,000.0)
$375,000.0

Total after-tax investment

After-tax
($5,400,000.0)
($5,000,000.0)
$1,666,666.7
($450,000.0)
$225,000.0
($8,958,333.3)

Annual Flotation Cost Tax Effects: t = 1 to 20

Annual tax savings from new-issue flotation costs
Annual lost tax savings from old-issue flotation costs
Net flotation cost tax savings
Annual Interest Savings Due to Refunding: t = 1 to 20
Interest on old bond
Interest on new bond
Net interest savings

$200,000.0
($166,666.7)

$80,000.0
($66,666.7)

$33,333.3

$13,333.3

$9,000,000.0

$5,400,000.0

($6,750,000.0)

($4,050,000.0)

$2,250,000.0

$1,350,000.0

Calculating the annual flotation cost tax effects and the annual interest savings
Annual Flotation Cost Tax Effects
Maturity of the new bond (Nper)
After-tax cost of new debt (Rate)
Annual flotation cost tax savings (Pmt)

Annual Interest Savings

Maturity of the new bond (Nper)
After-tax cost of new debt (Rate)
Annual interest savings (Pmt)

25
5.4%
$13,333

NPV of annual flotation cost savings

$180,611.111

25
5.4%
$1,350,000

NPV of annual interest savings

$18,286,874.96

Hence, the net present value of this bond refunding project will be the sum of the initial outlay and the present values of the annual flotation cost tax effects and interest savings.

Bond Refunding NPV =

Bond Refunding NPV =

Bond Refund NPV =

Initial Outlay
($8,958,333.33)

$9,509,152.73

+
+

PV of flotation costs
$180,611.11

+ PV of interest savings
+

$18,286,874.96

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9.0%

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7.0%

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9.0%

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11.0%