# Bond questions

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7-1 Bond valuation Callaghan Motors' bonds have 10 years remaining to maturity. Interest is paid annually; they have a $1,000 par value; the coupon interest rate is 8 percent; and the yield to maturity is 9 percent. What is the bond's current market price?

7-2 Current yield and yield to maturity A bond has a $1,000 par value, 10 years to maturity,

a 7 percent annual coupon, and sells for $985.

a. What is its current yield?

b. What is its yield to maturity (YTM)?

c. Assume that the yield to maturity remains constant for the next 3 years. What willthe price be 3 years from today?

7-3 Bond valuation Nungesser Corporation's outstanding bonds have a $1,000 par value, a 9 percent semiannual coupon, 8 years to maturity, and an 8.5 percent YTM. What is the bond's price?

7-8 Yield to call Six years ago, the Singleton Company issued 20-year bonds with a 14 percent annual coupon rate at their $1,000 par value. The bonds had a 9 percent call premium, with 5 years of call protection. Today, Singleton called the bonds. Compute the realized rate of return for an investor who purchased the bonds when they were issued and held them until they were called. Explain why the investor should or should not be happy that Singleton called them.

7-10 Current yield, capital gains yield, and yield to maturity Hooper Printing Inc. has bonds outstanding with 9 years left to maturity. The bonds have an 8 percent annual coupon rate and were issued 1 year ago at their par value of $1,000, but due to changes in interest rates, the bond's market price has fallen to $901.40. The capital gains yield last year was _9.86 percent.

a. What is the yield to maturity?

b. For the coming year, what is the expected current yield and the expected capital gains yield?

c. Will the actual realized yields be equal to the expected yields if interest rates change? If not, how will they differ?

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#### Solution Preview

7-1 Bond valuation Callaghan Motors' bonds have 10 years remaining to maturity. Interest is paid annually; they have a $1,000 par value; the coupon interest rate is 8 percent; and the yield to maturity is 9 percent. What is the bond's current market price?

The current market price is the present value of interest and the principal. The interest amount is $80 (1,000X8%), principal amount is $1,000. The time period is 10 years and the discounting rate is 9%( the YTM is the discounting rate). The current price is

Current price = 80 X PVIFA (10,9%) + 1,000 X PVIF (10,9%)

Current Price = 80 X 6.418 + 1,000 X 0.422

Current Price = $935.44

We use PVIFA table for interest as it is an annuity and PVIF for principal as it is a lump sum.

7-2 Current yield and yield to maturity A bond has a $1,000 par value, 10 years to maturity,

a 7 percent annual coupon, and sells for $985.

a. What is its current yield?

Current Yield = Annual Interest / Market Price

Annual Interest = 1,000X7%=$70

Market Price = $985

Current Yield = 70/985 = 7.11%

b. What is its yield to maturity (YTM)?

The YTM is the discounting rate that will make the Present Value of interest and principal equal to the price today. This is calculated using a ...

#### Solution Summary

The solution explains various calculations relating to bond yields and price.

Lease and Bond valuation questions

1. A lease versus purchase analysis should compare the cost of leasing to the cost of ownin, assuming that the asset purchased

A. is financed with short-term debt

B. is financed with long-term debt.

C. is financed with debt whose maturity matches the term of the lease.

D. is financed with a mix of debt and equity based on the firm's target capital structure, i.e. at the WACC.

E. is financed with retained earnings.

2. In the lease versus buy decision, leasing is often preferable.

A. because it has no effect on the firm's ability to borrow to make other investments.

B. because, generally, no down payment is required and there are no indirect interest costs.

C. because lease obligations do not affect the firm's risk as seen by investors.

D. because lessee owns the property at the end of the lease term.

E. because the lessee may have greater flexibility in abandoning the project in which the leased propertty is used than if the lessee bought and owned the asset.

3. The City of Charleston issued $3,000,000 of 8% coupon, 30-year, semiannual payment, tax-exempty muni bonds 10 years ago. The bonds had 10 years of call protection, but now the bonds can be called if the city chooses to do so. The call premium would be 6% of the face amount. New 20-year 6% semiannual payment bonds can be sold at par, but flotation costs on this issue would be 2% of the amount of bonds sold. What is the net present value of refunding? Note that cities pay no income taxes, hence taxes are not relevant.

A. $453,443

B. $476,115

C. $499,921

D. $524,917

E. $551,163

4. Tuttle Buildings Inc. has decided to go public by selling $5,000,000 of new common stock. Its investment bankers agreed to take a smaller fee now (6% of gross proceeds versus their normal 10%) in exchange for a 1-year option to purchase an additional 200,000 shares at %5,00 per share. The investment bankers expect to exercise the option and purchase the 200,000 shares in exactly one year, when the stock price is forecasted to be $6.50 per share. However, there is a chance that the stock price will actually be $12,00 per share one year from now. If the $12 price occurs what would the present value of the entire underwriting compensation be? assume that the investment banker's required return on such arrangement is 15% and ignore taxes.

A. $1,235,925

B. $1,300,973

C. $1,369,446

D. $1,441,522

E. $1,517,391

5. Financial Accounting STandards Board (FASB) Statement #13 requires that for an unqualified audit report, financial (or capital) leases must be included in the balance sheet by reporting the

A. residual value of a fixed asset.

B. residual value as a liability.

C. present value of future lease payments as an asset and also showing this same amount as an offsetting liability.

D. undiscounted sum of future lease payments as an asset and an offsetting liability.

E. undiscounted sum of future lease payments, less the residual value, as an asset and as an offsetting liability.

6. A central question that must be addressed in bankruptcy proceedings is whether the firm's inability to meet scheduled interest payments results from a temporary cash flow problem or from a potentially permanent problem caused by falling asset values.

A. True

B. False

7. Operating leases often have terms that include

A. maintenance of the equipment by the lessor.

B. full amortization over the life of the lease.

C. very high penalties if the lease is cancelled.

D. restrictions on how much the leased property can be used.

E. much longer lease periods than for most financial leases.

8. The primary test of feasibility in a reorganization is whether the firm's fixed charges after reorganization can be covered by its projected cash flows.

A. True

B. False

9. Which of the following factors would increase the likelihood that a company would call its outstanding bonds at this time?

A. The yield to maturity on the company's outstanding bonds increases due to a weakening of the firm's financial situation.

B. A provision in the bond indenture lowers the call price on specific dates, and yesterday was on of those dates.

C. The flotation costs associated with issuing new bonds rise.

D. The firm's CFO believes that interest rates are likely to decline in the future.

E. The firm's CFO believes that corporate tax rates are likely to be increased in the future.

10. Thompson Enterprises has $5,000,000 of bonds outstanding. Each bond has a maturity value of $1,000, an annual coupon of 12.0% and 15 years left to maturity. The bonds can be called at any time with a premium of $50 per bond. If bonds are called, the company must pay flotation costs of $10 per new refunding bond. Ignore tax considerations--assume that the firm's tax rate is zero.

The company's decision of whether to call the bonds depends critically on the current interest rate on newly issued bonds. What is the breakeven interest rate, the rate below which it would be profitable to call in the bonds?

A. 9.57%

B. 10.07%

C. 10.60%

D. 11.16%

E. 11.72%

11. Kohers Inc. is considering a leasing arrangement to finance some manufacturing tools that it needs for the next 3 years. The tools will be obsolete and worthless after 3 years. The form will depreciate the cost of the tools on a straight-line basis over their 3-year life. It can borrow $4,800,000, the purchase price, at 10% and buy the tools, or it can make 3 equal end-of-year lease payments of $2,100,000 each and lease them. The loan obtained from the bank is a 3-year simple interest loan, with interest paid at the end of the year. The firm's tax rate is 40%. Annual maintenance costs associated with ownership are estimated at $240,000, but this cost would be borne by the lessor if it leases. What is the net advantage to leasing (NAL), in thousands?

A. $96

B. $106

C. $112

D. $117

E. $123

12. Which of the following statements is most CORRECT?

A. If new debt is used to refund old debt, the correct discount rate to use in the refunding analysis is the before-tax cost of new debt.

B. The key benefits associated with refunding debt are the reduction in the firm's debt ratio and the creation of more reserve borrowing capacity.

C. The mechanics of finding the NPV of a refunding decision are fairly straightforward. However, the decision of when to refund is not always clear because it requires a forecast of future interest rates.

D. If a firm with a positive NPV refunding project delays refunding and interest rates rise, the firm can still obtain the entire NPV by locking in a low coupon rate when the rates are low, even though it actually refunds the debt after rates have risen.

E. Suppose a firm is considering refunding and interest rates rise during time when analysis is being done. The rise in rates would tend to lower the expected price of the new bonds, which would make them cheaper to the firm and thus increase the expected interest savings.

13. From the lessee viewpoint, the riskiness of the cash flows, with the possible exception of the residual value, is about the same as the riskiness of the lessee's

A. equity cash flows.

B. capital budgeting project cash flows.

C. debt cash flows.

D. pension fund cash flows.

E. sales.

14. Chapter 7 of the Bankruptcy Act is designed to do which of the following?

A. Protect shareholders against creditors.

B. Establish the rules of reorganization for firms with projected cash flows that eventually will be sufficient to meet debt payments.

C. Ensure that the firm is viable after emerging from bankruptcy.

D. Allow the firm to negotiate with each creditor individually.

E. Provide safeguards against the withdrawal of assets by the owners of the bankrupt firm and allow insolvent debtors to discharge all of their obligations and to start over unhampered by a burden of prior debt.

15. In the event of bankruptcy under the federal bankruptcy laws, debtholders have a prior claim to a firm's income and assets before both common and preferred stockholders. Moreover, in a bankruptcy all debtholders are treated equally as a single class of claimants.

A. True

B. False