Question

Olympic Corp sold an issue of bonds with a 15-year maturity, a $1,000 face value, and a 10% coupon rate with interest being paid semiannually. The market rate of interest when the bonds were issued was 10%. Two years after the bonds were issued, the market rate rose to 13%. The most recent common-stock dividend for Olympic Corp was $3.45 per share. Due to its stable sales and earnings, the firm’s management predicts dividends will remain at the current level for the foreseeable future.

REPLY POST: Question 1

Assume instead two years after the bonds were issued, the market rate fell to 8%.

1) Are these bonds a premium or a discount bond?

2) Calculate the selling price for the bonds at the following time periods: 1) Two years after issue (assuming semiannual interest) 2) Five years after issue (assuming annual interest)

3) Suppose the bond described above in the primary post (part 3/question 2) with annual interest are priced at $895.50, 5 years after issue. Should Olympic Corp purchase the bond? What is the maximum price they should pay for that bond?

4) What is the value of the common stock for Olympic Corp if the required return increases to 10%?

Answer 1

1) The bonds were issued originally at par since the coupon rate was equal to the market rate then.

2)

3) Question 2 is not given, hence will not be able to answer this part.

4) Stock price = Dividend / Required return = 3.45/ 10% = 34.5