Question

28.Zero Coupon Bonds Suppose your company needs to raise $50 million and you want to issue 30-year bonds for this purpose. Assume the required return on your bond issue will be 7 percent and you’re evaluating two issue alternatives: a semiannual coupon bond with a 7 percent coupon rate and a zero-coupon bond. Your company’s tax rate is 21 percent. Both bonds would have a par value of $1,000. a. How many of the coupon bonds would you need to issue to raise the $50 million? How many of the zeroes would you need to issue? b. In 30 years, what will your company’s repayment be if you issue the coupon bonds? What if you issue the zeroes? c. Based on your answers in (a) and (b), why would you ever want to issue the zeroes? To answer, calculate the firm’s after-tax cash outflows for the first year under the two different scenarios. Assume the IRS amortization rules apply for the zero-coupon bonds.

Answer 1

As per rules I am answering the first 4 subparts of the question

1: Using financial calculator

Input

Number of semiannual periods = 30*2 = 60

Rate of return = I/Y = 7/2= 3.5

Par value = FV = 1000

Semiannual coupon =PMT=7%*1000/2 = 35

Find

Price = PV = 1000

Hence number of bonds to issue = 50,000,000/1000 = 50,000

2: Using financial calculator

Input

Number of periods = 30

Rate of return = I/Y = 7

Par value = FV = 1000

Find

Price = PV = 131.37

Hence number of bonds to issue = 50,000,000/131.37 = 380612.752

Or 380613 Zero bonds

3: Repayment incase of coupon bonds= Par value*number of bonds

= 1000*50000 = $50,000,000

4: Repayment in case of zeros = Par value* number of bonds

=1000* 380613

=$380,613,000