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

Question

Tom Cruise Lines, Inc., issued bonds five years ago at $1,000 per bond. These bonds had a 20-year life when issued and the annual interest payment was then 13 percent. This return was in line with the required returns by bondholders at that point as described below:

Real rate of return 4 %
Inflation premium 5
Risk premium 4
Total return 13 %

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 15 years remaining until maturity. Compute the new price of the bond.
Use Appendix B and Appendix D. (Round "PV Factor" to 3 decimal places, intermediate and final answer to 2 decimal places. Omit the "$" sign in your response.)
New price $

Explanation / Answer

Tom Cruise Lines, Inc.
First compute the new required rate of return (yield tomaturity).
Real rate of return= 4%

Inflation premium= 3%

Risk premium=4%

Total return= 11%

Then use this value to find the price of the bond.
Present Value of Interest Payments

PVA = A × PVIFA (n = 15, i = 11%)

PVA = $130 × 7.1909 = $934.817

Present Value of Principal Payment at Maturity

PV = FV × PVIF (n = 15, i = 11%)Appendix B

PV = $1,000 × .209 = $209

934.817+209= $1143.817

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