Suppose Nike arranges for $1 billion of strip financing to be used in a leveraged buyout. The strip financing is composed of three items: a $400 million bank loan, $500 million of bonds, and $100 million of common shares. The $500 million bonds are subsidized in that they only pay a 4% coupon even though the going market rate on such bonds is 9%. The bank loan is not subsidized. The LBO firm will pay the interest (i.e. coupon) plus an additional $20 million of principle each year on the subsidized bonds for the next 4 years. It is anticipated that in the fifth year the firm will go public again and repay the outstanding principle and interest on these bonds. The expected payments are given below.

Year 0 1 2 3 4 5

Interest payment - 20 19.2 18.4 17.6 16.8

Additional payment - 20 20 20 20 420

Principle due 500 480 460 440 420 0

What would be the PV of the bond component if the true going rate for such bonds was 4%?

Group of answer choices

-5

0

5

10