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Chapter 16: Long-Term Debt and Lease Financing
a. Bond A
Bond B
payment) (Principal .4bond) theof (Price .6
maturity toyears ofNumber
bond theof Pricepayment Principal
paymentinterest Annual
)Y'(+
−
+
=
16-4. (Continued)
$1,000 $900
$82 2
.6($900) .4($1,000)
$100
$82 2
$540 $400
$82 $50
$940
$132 14.04%
−
+
=
+
+
=
+
+
=
Chapter 16: Long-Term Debt and Lease Financing
16-12
5. Secured vs. unsecured dept (LO1) Match the yield to maturity in column 2 with the
security provisions (or lack thereof) in column 1. Higher returns tend to go with greater
risk.
(1)
(2)
a. Debenture ............................
a. 7.79%
b. Secured debt ........................
b. 9.17%
c. Subordinated debenture ........
c. 8.67%
16-5. Solution:
Security Provision
Yield to Maturity
a. Debenture
a. 8.67%
b. Secured debt
b. 7.79%
c. Subordinated debenture
c. 9.17%
6. Bond value (LO2) The Florida Investment Fund buys 90 bonds of the Gator Corporation
through a broker. The bonds pay 8 percent annual interest. The yield to maturity (market
rate of interest) is 10 percent. The bonds have a 25-year maturity.
Using an assumption of semiannual interest payments:
a. Compute the price of a bond (refer to “Semiannual interest and bond prices” in
Chapter 10 for review if necessary).
b. Compute the total value of the 90 bonds.
16-6. Solution:
Chapter 16: Long-Term Debt and Lease Financing
16-13
Florida Investment Company
a. Present value of interest payments
Present value of principal payment at maturity
PV = FV × PVIF (n = 50, i = 5%) Appendix B
Total present value
Present value of interest payments $730.24
b. Value of 90 bonds
7. Bond value (LO2) Cox Media Corporation pays an 11 percent coupon rate on debentures
that are due in 20 years. The current yield to maturity on bonds of similar risk is 8 percent.
The bonds are currently callable at $1,060. The theoretical value of the bonds will be equal
to the present value of the expected cash flow from the bonds.
Chapter 16: Long-Term Debt and Lease Financing
16-14
a. Find the theoretical market value of the bonds using semiannual analysis.
b. Do you think the bonds will sell for the price you arrived at in part a? Why?
16-7. Solution:
Cox Media Corporation
a. Present value of interest payments
PVA = A × PVIFA (n = 40, i = 4%) Appendix D
Present value of principal payment at maturity
PV = FV × PVIF (n = 40, i = 4%) Appendix B
Total present value
Present value of interest payments $1,088.62
b. No. The call price of $1,060 will keep the bonds from getting
8. Effect of bond rating change (LO2) The yield to maturity for 15-year bonds is as follows
for four different bond rating categories:
Aaa
9.4% ...........................
Aa2
10.0%
Aal
9.6% ...........................
Aa3
10.2%
The bonds of Falter Corporation were rated as Aal and issued at par a few weeks ago.
Chapter 16: Long-Term Debt and Lease Financing
16-15
The bonds have just been downgraded to Aa2. Determine the new price of the bonds,
assuming a 15-year maturity and semiannual interest payments. (Refer to “Semiannual
Interest and Bond Prices” in Chapter 10 for a review if necessary.)
16-8. Solution:
With a Aal rating at issue, the coupon rate is 9.6% annually or
Present value of interest payments
PVA = A × PVIFA (n = 30, i = 5%) Appendix D
Present value of principal payment at maturity
PV = FV × PVIF (n = 30, i = 5%) Appendix B
Total present value
Present value of interest payments $737.86
9. Interest rates and bond ratings (LO2) Twenty-five-year B-rated bonds of Katz Copying
Machines were initially issued at a 12 percent yield. After 10 years the bonds have been
upgraded to Aa2. Such bonds are currently yielding 10 percent. Use Table 16–3 to
determine the price of the bonds with 15 years remaining to maturity. (You do not need the
bond ratings to enter the table; just use the basic facts of the problem.)
16-9. Solution:
Katz Copying Machines
Using Table 16-3:
Chapter 16: Long-Term Debt and Lease Financing
16-16
10. Interest rates and bond ratings (LO2) A previously issued A2, 15-year industrial bond
provides a return one-fourth higher than the prime interest rate of 8 percent. Previously
issued A2 public utility bonds provide a yield of three-eighths of a percentage point higher
than previously issued A2 industrial bonds of equal quality. Finally, new issues of A2
public utility bonds pay one-fourth of a percentage point more than previously issued A2
public utility bonds.
What should be the interest rate on a newly issued A2 public utility bond?
16-10. Solution:
Interest rate on previously issued
A2 15-year industrial bonds 8% × 1.25 = 10.000%
Additional return on A2 15-year
11. Zero-coupon rate bond (LO2) A 20-year, $1,000 par value zero-coupon rate bond is to be
issued to yield 11 percent.
a. What should be the initial price of the bond? (Take the present value of $1,000 for 20
years at 11 percent, using Appendix B.)
b. If immediately upon issue, interest rates dropped to 9 percent, what would be the
value of the zero-coupon rate bond?
c. If immediately upon issue, interest rates increased to 13 percent, what would be the
value of the zero-coupon rate bond?
16-11. Solution:
Chapter 16: Long-Term Debt and Lease Financing
16-17
a. PV of $1,000 for n = 20, i = 11%, PVIF = .124
b. PV of $1,000 for n = 20, i = 9%, PVIF = .178
c. PV of $1,000 for n = 20, i = 13%, PVIF = .087
12. Zero-coupon bond Yield (LO2) What is the effective yield to maturity on a zero-coupon
bond that sells for $116 and will mature in 25 years at $1,000? (Compute PVIF and go to
Appendix B for the 25-year figure to find the answer or compute FVIF and go to Appendix
A for the 25-year figure to find the answer. Either approach will work.)
16-12. Solution:
IF
PV $116
PV .116
FV $1,000
= = =
or
IF
IF
IF
FV $1,000
FV 8.621
PV $116
= = =
Chapter 16: Long-Term Debt and Lease Financing
16-18
13. Floating rate bond (LO2) You buy a 7 percent, 30-year, $1,000 par value, floating rate
bond in 2008. By the year 2011, rates on bonds of similar risk are up to 9 percent. What is
your one best guess as to the value of the bond?
16-13. Solution:
14 Effect of inflation on purchasing power of bond (LO2) Twelve years ago, the Archer
Corporation borrowed $6,000,000. Since then, cumulative inflation has been 80 percent (a
compound rate of approximately 5 percent per year).
a. When the firm repays the original $6,000,000 loan this year, what will be the effective
purchasing power of the $6,000,000? (Hint: Divide the loan amount by one plus
cumulative inflation.)
b. To maintain the original $6,000,000 purchasing power, how much should the lender
be repaid? (Hint: Multiply the loan amount by one plus cumulative inflation.)
c. If the lender knows he will receive only $6,000,000 in payment after 12 years, how
might he be compensated for the loss in purchasing power? A descriptive answer is
acceptable.
16-14. Solution:
Archer Corporation
a.
Loan amount $6,000,000 $3,333,333
1 Cumulative inflation 1.80
==
+
b. $6,000,000 × 1.80 = $10,800,000
Chapter 16: Long-Term Debt and Lease Financing
16-19
15. Profit potential associated with margin (LO2) A $1,000 par value bond was issued 25
years ago at a 12 percent coupon rate. It currently has 15 years remaining to maturity.
Interest rates on similar debt obligations are now 8 percent.
a. What is the current price of the bond? (Look up the answer in Table 16–3.)
b. Assume Ms. Russell bought the bond three years ago when it had a price of $1,070.
What is her dollar profit based on the bond’s current price?
c. Further assume Ms. Russell paid 30 percent of the purchase price in cash and
borrowed the rest (known as buying on margin). She used the interest payments from
the bond to cover the interest costs on the loan. How much of the purchase price of
$1,070 did Ms. Russell pay in cash?
d. What is Ms. Russell’s percentage return on her cash investment? Divide the answer to
part b by the answer to part c.
e. Explain why her return is so high.
16-15. Solution:
Ms. Russell
a. The original bond was issued at 12%
Chapter 16: Long-Term Debt and Lease Financing
16-15. (Continued)
d.
Dollar profit $275.52
Purchase price paid in cash $321.00
=
e. Ms. Russell has not only benefited from an increase in the
16. Loss exposure and profit potential (LO2) A $1,000 par value bond was issued 25 years
ago at a 7 percent coupon rate. It currently has 10 years remaining to maturity. Interest
rates on similar debt obligations are now 12 percent.
a. Compute the current price of the bond using an assumption of semiannual payments.
b. If Mr. Robinson initially bought the bond at par value, what is his percentage loss
(or gain)?
c. Now assume Mrs. Pinson buys the bond at its current market value and holds it to
maturity, what will her percentage return be?
d. Although the same dollar amounts are involved in part b and c, explain why the
percentage gain is larger than the percentage loss.
16-16. Solution:
Mr. Robinson – Mrs. Pinson
a. Present value of interest payments
PVA = A × PVIFA (n = 20*, i = 6%) Appendix D
