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Chapter 4: Q10-21BP (page 324)

Heather Smith is considering a bond investment in Locklear Airlines. The $1,000 par value bonds have a quoted annual interest rate of 11 percent and the interest is paid semiannually. The yield to maturity on the bonds is 14 percent annual interest. There are seven years to maturity. Compute the price of the bonds based on semiannual analysis.

Short Answer

Expert verified

The current price of bond is computed as$868.82

Step by step solution

01

Computation of Present Value of Interest

PresentValueofInflowInterest=Payment(1-1(1+i)n)=55(1-1(1+0.055)14)=$481

02

Computation of present value of maturity amount

PresentValueofMaturity=Payment(1-1(1+i)n)=1,000(1-1(1+0.07)14)=$387.82

03

Computation of price of bond

Priceofbond=PresentValueofInterest+PresentValueofmaturity=481+387.82=868.82

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Most popular questions from this chapter

Explain how the concept of risk can be incorporated into the capital budgeting process

Russell Container Corporation has a \(1,000 par value bond outstanding with 30 years to maturity. The bond carries an annual interest payment of \)105 and is currently selling for $880 per bond. Russell Corp. is in a 40 percent tax bracket. The firm wishes to know what the aftertax cost of a new bond issue is likely to be. The yield to maturity on the new issue will be the same as the yield to maturity on the old issue because the risk and maturity date will be similar. a. Compute the yield to maturity on the old issue and use this as the yield for the new issue. b. Make the appropriate tax adjustment to determine the aftertax cost of debt.

KeySpan Corp. is planning to issue debt that will mature in 2035. In many respects, the issue is similar to currently outstanding debt of the corporation. a. Using Table 11-3, identify the yield to maturity on similarly outstanding debt for the firm in terms of maturity. b. Assume that because the new debt will be issued at par, the required yield to maturity will be 0.15 percent higher than the value determined in part a. Add this factor to the answer in a. (New issues sold at par sometimes requirea slightly higher yield than older seasoned issues because there are fewer tax advantages and more financial leverage that increase company risk.) c. If the firm is in a 30 percent tax bracket, what is the aftertax cost of debt?

The Suboptimal Glass Company uses a process of capital rationing in its decision making. The firm鈥檚 cost of capital is 10 percent. It will only invest \(77,000 this year. It has determined the internal rate of return for each of the following projects:

Project

Project size

Internal rate of return

A

\)10,500

21%

B

30,500

22

C

25,500

18

D

10,500

13

E

10,500

20

F

20,500

11

G

10,500

16

a. Select the projects that the firm should accept.

b. If Projects A and B are mutually exclusive, how would that affect your overall answer? That is, which projects would you accept in spending the $77,000?

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?
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