3. 27.

Zero coupon bonds [LO 7.2] Suppose your company needs to raise

$53 million and you want to issue 20-year bonds for this purpose.

Assume the required return on your bond issue will be 5.3 per cent, and you are evaluating two issue alternatives: a semiannual coupon bond with a coupon rate of 5.3 per cent and a zero coupon bond. Your company’s tax rate is 30 per cent. Both bonds will have a face value of

$1 000.

1. How many of the coupon bonds would you need to issue to raise the $53 million? How many of the zeroes would you need to issue?

2. In 20 years, what will your company’s repayment be if you issue the coupon bonds? What if you issue the zeroes?

3. Based on your answers in

(a) and (b), why would you ever want to issue the zeroes? To answer, calculate the firm’s after-tax cash flows for the first year under the two different scenarios. Assume the ATO amortisation rules apply for the zero coupon bonds.