Question
Wilson Oil Company issued bonds five years ago at $1,000 per bond. These bonds had a 25-year life when issued and the annual interest payment
Wilson Oil Company issued bonds five years ago at $1,000 per bond. These bonds had a 25-year life when issued and the annual interest payment was then 15 percent. This return was in line with the required returns by bondholders at that point in time as described next:
Real rate of return ........................... 8%
Inflation premium ........................... 3
Risk premium ............................... 4
Total return ................................... 15%
Assume that 10 years later, due to bad publicity, the risk premium is now 7 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.
This is what I came up with - but feel it is wrong.
Real Rate of Return 8%
Inflation Premium 3%
Risk Premium 7%
8% Total Required Return
N=15, I/Y = 18, PV =CPT PV -847.25, PMT = 150, FV 1,000
Bond Price = $847.25
Present Value of Interest Payments
PVA = A X PVIFA (n=15, i=18%)
PVA = $150 x 5.092 = $763.80
Present Value of Principal Payment Maturity
PV=FVxPVIF (n=15,i=18%)
PV = $1,000 x .084 = $84.00
$763.80 + $84.00 = $847.80
Bond Price = $847.80
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started