Tom Cruise Lines Inc. issued bonds five years ago at $1,000 per bond. These bond

Question

Tom Cruise Lines Inc. issued bonds five years ago at $1,000 per bond. These bonds had a 35-year life when issued and the annual interest payment was then 14 percent. This return was in line with the required returns by bondholders at that point as described below:

Assume that five years later the inflation premium is only 3 percent and is appropriately reflected in the required return (or yield to maturity) of the bonds. The bonds have 30 years remaining until maturity.
  
Compute the new price of the bond. Use Appendix B and Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods. (Do not round intermediate calculations. Round your final answer to 2 decimal places. Assume interest payments are annual.)
  

Real rate of return 3 % Inflation premium 6 Risk premium 5 Total return 14 % Appendix B Present value of $1,PVF PV=FV Percent Period 4 Appendlx B (concluded) Percent Period 50% 0.783 0.769 0.756 0.743 0.731 0.718 0.706 0.694 0.640 0.592 0.549 0.510 0.444 0.693 0.675 0.658 0.641 0.624 0.609 0.593 0.579 0512 0.455 0.406 0.364 0.296 0.480 0.456 0.432 0.410 0.390 0.370 0.352 0.335 0.262 0.207 0.165 0.133 0.088 0.425 0.400 0.376 0.354 0.333 0.314 0.296 0.279 0.210 0.159 0.122 0.095 0.059 0.261 0.237 0.215 0.195 0.178 0.162 0.148 0.135 0.086 0.056 0.037 0.025 0.012 0.160 0.140 0.123 0.108 0.095 0.084 0.074 0.065 0.035 0.020 0.011 0.006 0.002 0.125 0.108 0.093 0.080 0.069 0.060 0.052 0.045 0.023 0.012 0.006 0.003 0.001 0.098 0.083 0.070 0.060 0.051 0.043 0.037 0.031 0.014 0.007 0.003 0.002 0 0.087 0.073 0.061 0.051 0.043 0.037 0.031 0.026 0.012 0.005 0.002 0.001 0 0.047 0.038 0.030 0.024 0.020 0.016 0.013 0.010 0.004 0.001 0.001 0 0.026 0.020 0.015 0.012 0.009 0.007 0.005 0.004 0.001 0

Explanation / Answer

Present value of bond after 5 year = coupon * summation ( present value of interest rate for next 30 years) + 1000 * present value at 30 years

since inflation is decreased by 3% current reuird rate of return by investors will be decreased by 3% as well which will become 11%. So we will take the values from appendix B with 11% rate.

Bond Price = 140 * ( .901 + .812 + .731 + ..........+ .044) + 1000*.044

= 1216.8137 + 44

= $1260.81

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