The amortization of flotation costs reduces taxes and thus provides an annual cash flow. What will the net increase or decrease in the annual flotation cost tax savings be if refunding takes place

New York Waste (NYW) is considering refunding a $50,000,000, annual payment, 14% coupon, 30-year bond issue that was issued 5 years ago. It has been amortizing $3 million of flotation costs on these bonds over their 30-year life. The company could sell a new issue of 25-year bonds at an annual interest rate of 11.67% in today's market. A call premium of 14% would be required to retire the old bonds, and flotation costs on the new issue would amount to $3 million. NYW's marginal tax rate is 40%. The new bonds would be issued when the old bonds are called.The amortization of flotation costs reduces taxes and thus provides an annual cash flow.

a) What will the net increase or decrease in the annual flotation cost tax savings be if refunding takes place?

a. $6,480 b. $7,200 c. $8,000 d. $8,800 e. $9,680

C. $8,000

Explanation:

Given the following parameters

Amount: $50,000,000,

Call premium %: 14%

Old rate: 14.00%

Tax rate: 40%

Original life: 30

New rate: 11.67%

Years ago issued: 5

New life: 25

Original flotation cost: $3,000,000

New flotation cost: $3,000,000

Years remaining on old bond: 25

Then we solve for old new annual amortization tax effects:

Flotation costs benefit, new: ($3,000,000/25)(0.4) = $48,000

Flotation costs lost, old: ($3,000,000/30)(0.4) = $40,000

Net annual amortization tax effects = New flotation cost - Old floatation cost

=> $48,000 - $40,000 = $8,000

Hence, the right answer is $8,000

the earnings of a typical investor is around $1,000,000 to $10,000,000

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