Question

Smith Stationary Ltd needs to raise $500,000 to improve its manufacturing plant. It has decided to issue a $1,000 face value bond with a 8% annual coupon rate paid semi-annually and a 5-year maturity. The investors require 10% rate of return. a.Calculate the price of this bond. How many bonds need to be issued to receive the required amount of fund? b.What is the firm after-taxed cost of debt given the tax rate is 30%

Answer 1

Coupon is paid semi annually.

Hence, period is semi annual.

Part (a)

Price of the bond can be calculated using PV function in excel.

Inputs are:

Rate = required rate per period = Semi annual required rate = 10% / 2 = 5%

Period = nos. of half year in time to maturity = 2 x 5 = 10

PMT = Payment per period = Semi annual coupon = 8% / 2 x 1,000 = 40

FV = future value = face value = 1000

Hence, Price of the bond, P = - PV (Rate, Period, PMT, FV) = - PV (5%, 10, 40, 1000) = $ 922.78

Number of bonds to be issued, N = Amount to be raised / P = 500,000 / 922.78 = 542 (rounded off to the nearest integer)

Part (b)

Firm after-taxed cost of debt = Required return x (1 - tax rate) = 10% x (1 - 30%) = 7%