Question

Your are considering the purchase of a bond with a face value of $2500 due in 20 years that pays 5% interest. If your MARR is 7% what would you be willing to pay for it?

Answer 1

Face Value= $2500 which is the future value which we might get while redeeming the bond, so future value (FV) = $ 2500

Time (n)= 20

Coupon= 5%

Minimum acceptable rate of return which is the YTM is this case = 7%

Present value= PV of coupon amount + PV of Future value

= PV of ( 5% of $2500 for each of the 20 years) + PV of $2500

= PV of ($125 for each of the 20 years) + PV of $2500

= $125 * Present value interest factors for $1 annuity discounted at 7% for 20 periods(7%, 20) + $2500* PV of interest factor (7%, 20)

= $125* 10.594 + $2500* 0.258419

= $1324.25 + $646.0475

= $1970.298

Note 1: Calculation of 10.594 figure used above

PVIFA= [1- 1/(1+.07)^20] / 0.07

= 0.741581/ 0.07

= 0.594

Note 2: calculation of 0.258419 used above

PVIF= 1/(1+0.07)^20

= 0.258419