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Chapter 4: 3BP (page 321)

Exodus Limousine Company has $1,000 par value bonds outstanding at 10 percent interest. The bonds will mature in 50 years. Compute the current price of the bonds if the percent yield to maturity is

a. 5 percent.

b. 15 percent.

Short Answer

Expert verified
  1. Bond price for 5% yield to maturity is $1,912.80
  2. Bond price for 15% yield to maturity is $666.92

Step by step solution

01

Computation of coupon:

Coupon=Bondoutstanding脳Interest=$1000脳10%=$100

02

a. Computation on the basis of 5 percent.

  • Par value of bond (P) is $1,000.
  • Yield to maturity (r) is 5%.
  • Years to maturity (n) is 50.

Bondprice=Coupon脳[1-11+rn]r+P(1+r)n=100脳[1-11+0.0550]0.05+1000(1+0.05)50=100脳18.26+87.20=$1,912.80Bondprice=Coupon脳[1-11+rn]r+P(1+r)n=100脳[1-11+0.0550]0.05+1000(1+0.05)50=100脳18.26+87.20=$1,912.80

03

b. Computation on the basis of15 percent.

Bondprice=Coupon脳[1-11+rn]r+P(1+r)n=100脳[1-11+0.1550]0.15+$1000(1+0.15)50=$100脳6.66+0.92=$666.92

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Most popular questions from this chapter

Assume a firm has earnings before depreciation and taxes of \(200,000 and no depreciation. It is in a 40 percent tax bracket.

a. Compute its cash flow.

b. Assume it has \)200,000 in depreciation. Recompute its cash flow.

c. How large a cash flow benefit did the depreciation provide?

King鈥檚 Department Store is contemplating the purchase of a new machine for \(22,802. The machine will provide \)3,500 per year in cash flow for nine years. King鈥檚 has a cost of capital of 10 percent. Using the internal rate of return method, evaluate this project and indicate whether it should be undertaken.

Using Table 10-2:

a. Assume the interest rate in the market (yield to maturity) goes down to 8 percent for the 10 percent bonds. Using column 2, indicate what the bond price will be with a 10-year, a 15-year, and a 20-year time period.

b. Assume the interest rate in the market (yield to maturity) goes up to 12 percent for the 10 percent bonds. Using column 3, indicate what the bond price will be with a 10-year, a 15-year, and a 20-year period.

c. Based on the information in part a, if you think interest rates in the market are going down, which bond would you choose to own?

d. Based on information in part b, if you think interest rates in the market are going up, which bond would you choose to own?

Question:In computing the cost of capital, do we use the historical costs of existing debt and equity or the current costs as determined in the market? Why?(LO11-3)

The treasurer of Riley Coal Co. is asked to compute the cost of fixed income securities for her corporation. Even before making the calculations, she assumes the aftertax cost of debt is at least 3 percent less than that for preferred stock. Based on the following facts, is she correct?

Debt can be issued at a yield of 11.0 percent, and the corporate tax rate is 20 percent. Preferred stock will be priced at \(60 and pay a dividend of \)6.40. The flotation cost on the preferred stock is $6.
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