Reference no: EM132813135

Question 1 - Myra Breck must choose between two bonds: Bond A pays $180 annual interest with semiannual payment and has a market value of $880. It has 10 years to maturity.

Bond B pays $180 annual interest with semiannual payment and has a market value of $940. It has 2 years to maturity.

Assume the par value of the bonds is $1,000.

a. Compute the current yield on both bonds.

b. Which bond should she select based on the answer to part a?

c. A drawback of current yield is that it does not consider the total life of the bond. What is the yield to maturity on these bonds?

d. Has the answer changed between parts b and c of this question?

Question 2 - Pacific Western Corporation pays a 11 percent coupon rate on debentures due in 25 years. The current yield to maturity on bonds of similar risk is 10 percent. The bonds are currently callable at $1,260. The theoretical value of the bonds will be equal to the present value of the expected cash flow from the bonds. Assume the par value of the bonds is $1,000.

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?

Question 3 - The Harding Corporation has $51.9 million of bonds outstanding that were issued at a coupon rate of 12.75 percent seven years ago. Interest rates have fallen to 11.5 percent. Preston Alter, the vice-president of finance, does not expect rates to fall any further. The bonds have 18 years left to maturity, and Preston would like to refund the bonds with a new issue of equal amount also having 18 years to maturity. The Harding Corporation has a tax rate of 30 percent. The underwriting cost on the old issue was 4.4 percent of the total bond value. The underwriting cost on the new issue will be 1.8 percent of the total bond value. The original bond indenture contained a five-year protection against a call, with an 8 percent call premium starting in the sixth year and scheduled to decline by one-half percent each year thereafter (Consider the bond to be seven years old for purposes of computing the premium).

a. Compute the discount rate.

b. Calculate the present value of total outflows.

c. Calculate the present value of total inflows.

d. Calculate the net present value.

e. Should the Harding Corporation refund the old issue?