9. You are considering buying the bonds of a very risky company. A bond with a $
ID: 2815317 • Letter: 9
Question
9. You are considering buying the bonds of a very risky company. A bond with a $100 face value, a 1-year maturity, and a coupon rate of 22% is selling for $95. You consider the probability that the company will actually survive to pay off the bond 80%. With 20% probability, you think that the company will default, in which case you think that you will be able to recover $40. a. What is the expected return on the bond? b. If the company has cost of equity r-25%, tax rate Tc-35%, and 40% of its capital structure is equity, what is its weighted average cost of capital (WACC)?Explanation / Answer
For yield there is the formula i.e., =YIELD(settlement date, matuity date, rate, pr, redemption, frequency, [basis])
here we will select the value in the tab given above and will get the value for yield which will be used for calculation of WACC.
WACC = weight of equity * cost of equity + weight of dent* cost of debt * (1 - tax rate)
= .4* 25% + .6* 28.42%*(1-.35)
= 21.08%
Expected return of bond =( .8*(redemption value + coupon) + .2*default value -100)/100
= 5.6%
Bond Face value $ 100.00 Settlement date 9/13/2018 Coupon 22% Maturity date 9/13/2019 Present value $ 95.00 Time to maturity 1 Yeild to maturity 28.42% Total bond payment $122 Bond payment in case of default $40 Expected return on bond 5.60% WACC 21.08%Related Questions
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