Chapter 5: Q7BP (page 528)

Question:Cox Media Corporation pays an 11 percent coupon rate on debentures that are due in 10 years. The current yield to maturity on bonds of similar risk is 8 percent. The bonds are currently callable at $1,110. The theoretical value of the bonds will be equal to the present value of the expected cash flow from the bonds.
a. Find the market value of the bonds using semiannual analysis.
b. Do you think the bonds will sell for the price you arrived at in part a? Why?

Short Answer

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Answer

(a) The price per bond is computed as $1,203.85.

(b) Bonds should not be sold at this price, as call price is low.

Step by step solution

Computation of price of the bond

$\begin{array}{rcl} SemiannualCoupon & = & (\frac{CouponRate}{2}) \times FaceValue \\ = & (\frac{0.11}{2}) \times 1, 000 \\ = & $ 55 \\ Priceperbond & = & CouponPayment \times (\frac{1 - {(1 + r)}^{- n}}{r}) + \frac{FaceValue}{{(1 + r)}^{n}} \\ = & 55 \times (\frac{1 - {(1 + 0.04)}^{- 10 \times 2}}{0.04}) + \frac{1, 000}{{(1 + 0.04)}^{10 \times 2}} \\ = & $ 1, 203.85 \end{array}$

Bonds will sell or not

The current call price of the bond is $1,110 which indicates that the price of the bond computed in part a is less than the current call price. Therefore, the bond shouldn’t be sold at $1,203.85

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Assets
	Book value	Liquidation value
Accounts receivables	\(1,400,000	\)1,200,000
Inventory	\(1,800,000	\)900,000
Machinery and equipment	\(1,100,000	\)600,000
Building and plant	\(4,200,000	\)2,500,000
Total assets	\(8,500,000	\)5,200,000

Liabilities and stockholder’s claims
Liabilities
Accounts payable	\(2,800,000
First lien, secured by machinery and equipment	\)900,000
Senior unsecured debt	\(2,200,000
Subordinated debenture	\)1,700,000
Total liabilities	\(7,600,000
Stockholder’s claims
Preferred stock	\)250,000
Common stock	\(650,000
Total stockholder’s claims	\)900,000
Total liabilities and stockholder’s claims	$8,500,000

Short Answer

Step by step solution

Computation of price of the bond

Bonds will sell or not

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