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Chapter 4: Q2DQ (page 319)
Why might investors demand a lower rate of return for an investment in Microsoft as compared to United Airlines?
Investors are willing lower returns in the case of company M due to its lower financial rate and strong market position as compared to company UA.
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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.
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.
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?
Wilson Oil Company 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 in time as described next:
Real rate of return ........................ 8%
Inflation premium ......................... 3
Risk premium .............................. 4
Total return ............................... 15%
Assume that 10 years later, due to bad publicity, the risk premium is now 7 percent and is appropriately reflected in the required return (or yield to maturity) of the bonds. The bonds have 15 years remaining until maturity. Compute the new price of the bond.
Question: Determine the amount of money in a savings account at the end of 10 years, given an initial deposit of $5,500 and a 12 percent annual interest rate when interest is compounded (a) annually, (b) semiannually, and (c) quarterly.
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