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Chapter 4: 22BP (page 283)
If you owe $35,000 payable at the end of eight years, what amount should your creditor accept in payment immediately if she could earn 13 percent on her money?
The creditor should accept $13,165.60 now.
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If inflationary expectations increase, what is likely to happen to the yield to maturity on bonds in the marketplace? What is also likely to happen to the price of bonds?
What two components make up the required rate of return on common stock?
How does the modified internal rate of return include concepts from both the traditional internal rate of return and the net present value methods? (LO12-4)
Media Bias Inc. issued bonds 10 years ago at $1,000 per bond. These bonds had a 40-year life when issued and the annual interest payment was then 12 percent. This return was in line with the required returns by bondholders at that point in time as described next:
Real rate of return ........................ 2%
Inflation premium ......................... 5
Risk premium .............................. 5
Total return ............................... 12%
Assume that 10 years later, due to good publicity, the risk premium is now 2 percent and is appropriately reflected in the required return (or yield to maturity) of the bonds. The bonds have 30 years remaining until maturity. Compute the new price of the bond.
Essex Biochemical Co. has a $1,000 par value bond outstanding that pays 15 percent annual interest. The current yield to maturity on such bonds in the market is 17 percent. Compute the price of the bonds for these maturity dates:
a. 30 years.
b. 20 years.
c. 4 years.
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