Reference no: EM13809777

Panel del Sol Inc. (PdS) is a recently incorporated manufacturer of octagonal solar panels. The company has yet to reach profitability due to both the unsightly appearance of its solar panels and the ability of its Chilean competitors to produce an identical product at half the cost. Since high-cost solar panels are PdS’s only product, failure to reduce production costs during the next year is likely to force the company to default on its outstanding issue of zero coupon bonds, having one year to maturity and a face value of $1000. Although the CEO is confident that PdS can achieve the necessary cost reductions, there is a 25 percent probability that the firm will run out of money during the next year and file for Chapter 11 bankruptcy protection, in which case bondholders will receive 44 percent of the promised principal payment on the bonds. Zero coupon bonds issued by the US government having a par value of $1000 and one year to maturity are currently selling at a price of 95 percent (percent of their par value). Assuming that all interest rates should be quoted on an annually compounded basis and that investors value risky bonds by discounting their expected payoff at the risk-free rate, compare the annual yield to maturity for the zero coupon bonds issued by the government with the promised yield to maturity for Panel del Sol’s bonds.