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Chapter 4: Q11-4BP (page 363)
Telecom Systems can issue debt yielding 9 percent. The company is in a 30 percent bracket. What is its aftertax cost of debt?
After tax cost of debt of the company is $0.063.
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Tim Trepid is highly risk-averse while Mike Macho actually enjoys taking a risk.
a. Which one of the four investments should Tim choose? Compute coefficients of variation to help you in your choice.
Investments
Returns:
Expected Value
Standard Deviation
Buy stocks ..................................... \( 9,140 \) 6,140
Buy bonds ..................................... 7,680 2,560
Buy commodity futures ................. 19,100 26,700
Buy options ................................... 17,700 18,200
b. Which one of the four investments should Mike choose?
Jim Busby calls his broker to inquire about purchasing a bond of Disk Storage Systems. His broker quotes a price of \(1,180. Jim is concerned that the bond might be overpriced based on the facts involved. The \)1,000 par value bond pays 14 percent interest, and it has 25 years remaining until maturity. The current yield to maturity on similar bonds is 12 percent. Compute the new price of the bond and comment on whether you think it is overpriced in the marketplace.
Myers Business Systems is evaluating the introduction of a new product. The possible levels of unit sales and the probabilities of their occurrence are given next:
Possible Market Reaction Sales in Units Probabilities
Low response ....................................... 20 0.10
Moderate response .............................. 40 0.30
High response ...................................... 55 0.40
Very high response ............................... 70 0.20
a. What is the expected value of unit sales for the new product?
b. What is the standard deviation of unit sales?
Tom Cruise Lines Inc. issued bonds five years ago at $1,000 per bond. These bonds had a 25-year life when issued and the annual interest payment was then 15 percent. This return was in line with the required returns by bondholders at that point as described next:
Real rate of return ........................ 4%
Inflation premium ......................... 6
Risk premium .............................. 5
Total return ............................... 15%
Assume that five years later the inflation premium is only 3 percent and is appropriately reflected in the required return (or yield to maturity) of the bonds. The bonds have 20 years remaining until maturity. Compute the new price of the bond.
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.
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