1. (TCO D) Which of the following statements is most correct?

(a) If new debt is used to refund old debt, the correct discount rate to use in the refunding analysis is the before-tax cost of new debt.
(b)The key benefits associated with refunding debt are the reduction in the firm's debt ratio and the creation of more reserve borrowing capacity.
(c)The mechanics of finding the NPV of a refunding decision are fairly straightforward. However, the decision of when to refund is not always clear because it requires a forecast of future interest rates.
(d) If a firm with a positive NPV refunding project delays refunding and interest rates rise, the firm can still obtain the entire NPV by locking in a low coupon rate when the rates are low, even though it actually refunds the debt after rates have risen.
(e) Suppose a firm is considering refunding and interest rates rise during a time when the analysis is being done. The rise in rates would tend to lower the expected price of the new bonds, which would make them cheaper to the firm, and thus increase the expected interest savings. (Points : 20) | Question 2.2. (TCO D) Tuttle Buildings Inc. has decided to go public by selling $5,000,000 of new common stock. Its investment bankers agreed to take a smaller fee now (6% of gross proceeds versus their normal 10%) in exchange for a 1-year option to purchase an additional 200,000 shares at $5.00 per share. The investment bankers expect to exercise the option and purchase the 200,000 shares in exactly 1 year, when the stock price is forecasted to be $6.50 per share. However, there is a chance that the stock price will actually be $12.00 per share 1 year from now. If the $12 price occurs, what would the present value of the entire underwriting compensation be? Assume that the investment banker's required return on such arrangements is 15% and ignore taxes.