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Chapter 5: 15DQ (page 524)

Explain how the zero-coupon rate bond provides return to the investor. What are the advantages to the corporation? (LO16-2)

Short Answer

Expert verified

The zero-coupon rate bonds are issued at a deep discount from face value, and the difference between them is the return for investors.

Also, the company does not require to pay interest on such a variety of bonds, and such a bond also smoothens the corporation’s cash inflow.

Step by step solution

01

Return generation for investors

The return generated by the investors in zero-coupon-rated bonds is the difference between the cost incurred by the investor and the face value received at the bond’s maturity.

02

Advantages of zero-coupon rate bond

  • The corporations are not required to pay interest on a zero-coupon rate bond.
  • Zero-coupon-rated bonds facilitate the immediate inflow of cash and do not require any outflow before maturity.
  • The corporations may amortize the difference between initial bond price and maturity value throughout the life of the bond.

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Most popular questions from this chapter

Question: The Bowman Corporation has a \(18 million bond obligation outstanding, which it is considering refunding. Though the bonds were initially issued at 10 percent, the interest rates on similar issues have declined to 8.5 percent. The bonds were originally issued for 20 years and have 10 years remaining. The new issue would be for 10 years. There is a 9 percent call premium on the old issue. The underwriting cost on the new \)18,000,000 issue is \(530,000, and the underwriting cost on the old issue was \)380,000. The company is in a 35 percent tax bracket, and it will use an 8 percent discount rate (rounded after-tax cost of debt) to analyze the refunding decision.

c. Calculate the net present value.

American Health Systems currently has 6,400,000 shares of stock outstanding and will report earnings of \(10 million in the current year. The company is considering the issuance of 1,700,000 additional shares that will net \)30 per share to the corporation.

a. What is the immediate dilution potential for this new stock issue?

b. Assume that American Health Systems can earn 9 percent on the proceeds of the stock issue in time to include them in the current year’s results. Calculate earnings per share. Should the new issue be undertaken based on earnings per share?

Midland Corporation has a net income of \(19 million and 4 million shares outstanding. Its common stock is currently selling for \)48 per share. Midland plans to sell common stock to set up a major new production facility with a net cost of \(21,120,000. The production facility will not produce a profit for one year, and then it is expected to earn a 13 percent return on the investment. Stanley Morgan and Co., an investment banking firm, plans to sell the issue to the public for \)44 per share with a spread of 4 percent.

d. Compute the EPS and the price (P/E stays constant) after the new production facility begins to produce a profit.

The Pioneer Petroleum Corporation has a bond outstanding with an \(85 annual interest payment, a market price of \)800, and a maturity date in five years. Find the following:

a. The coupon rate.

b. The current rate.

c. The yield to maturity

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