Question

A company can raise money for a project by selling bonds. A typical bond has a face value of $1,000 and a 30-year life. The company will pay interest on the bond at the end of each year, and at the end of 30 years it will also redeem the bond (i.e., pay back the original $1,000). The interest rate is determined by market forces. What is the NPVof a 30-year bond paying 6% interest to someone with a discount rate of 6%? To someone with a discount rate of 5%? To someone with a discount rate of 7%?

NOTE: This question can be answered by creating a spreadsheet and showing the interest of $60 received at the end of years 1 to 30 and the return of the $1,000 at the end of year 30. Discount all of these payments using the investor’s discount rate, and sum to get the NPV of the bond to each investor.

Answer 1

If discount rate is equal to interest rate then Present value of future payment (interest and principle) of bond is equal to current price of bond. So on this case NPV of bond would be zero.

Again, if discount rate is equal to 5% then present value future payments is calculated in excel and screen shot provided below:

Present value of future payments that is current price of bond is $1,154.54.

NPV = $1,154.54 - $1,000

= $154.54.

if discount rate is 5% then NPV is $154.54.