Recently, the vice president of operations of the company has requested construc

Question

Recently, the vice president of operations of the company has requested construction of a new plant to meet the increasing demand for the company’s bicycles. After a careful evaluation of the request, the board of directors has decided to raise funds for the new plant by issuing $3,000,000 of 11 percent corporate bonds on April 1, 2019, due on April 1, 2033. Interest is payable annually on April 1 each year. At the time the bonds were issued, the market interest rate for similar financial securities is 10 percent. Determine the selling price of the bonds.

Explanation / Answer

Soln : Here the maturity of the bonds is 14 years from 2019 to 2033.

Interest payabale annually i.e. 11% and market interest rate/discounting rate = 10%

Let P be the price of the bond at which the bonds to be sold.

So, interest earned yearly = 11% *3000000 = $330000

Please refer the table using the NPV method by discounting at 10%, we have calculated the prices of the bond to be issued:

Selling Price of the bond = $3221000.62

Year 1 2 3 4 5 6 7 8 9 10 11 12 13 14 Cash flow 330000 330000 330000 330000 330000 330000 330000 330000 330000 330000 330000 330000 330000 3330000 Discount factor @10% 0.91 0.83 0.75 0.68 0.62 0.56 0.51 0.47 0.42 0.39 0.35 0.32 0.29 0.26 Present Value 300000.00 272727.27 247933.88 225394.44 204904.04 186276.40 169342.18 153947.44 139952.21 127229.29 115662.99 105148.17 95589.25 876893.08 NPV 3221000.62

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