Question

Permian Underground Machines & Pipes Co. (PUMP) is in the oil and gas equipment and services industry. It is considering a new oilfield services operation in the Permian Basin. This project would require an outlay of $50 million.

Suppose that PUMP hires Moody’s to assess the company’s credit quality if it were to issue the bonds. Moody’s advises PUMP that it would rate its bonds as Caa.

Managers at PUMP consider issuing a 20-year bond. Currently, the yield on a U.S. Treasury bond with about 20 years to maturity is 1.81%.

Estimate the required rate of return for the bond that PUMP managers are considering.

Group of answer choices

9.30%

12.44%

18.71%

2.28%

1.81%

Answer 1

Junk Bonds are considered high risk and they are generally rated BB or lower by Standard & Poor's and Ba lower by Moody's. Since Permian Underground Machines & Pipes Co. is rated by Moody's that would rate its bonds as Caa. A high investment risk means so Permian Underground Machines & Pipes Co. when it requires a $50 million outlay so if they issue bonda they will get it at the minimum rate possible which is 1.81% as it the rate as a 20year old U.S. Treasury Bond. Hence, if they issue bonds, they will receive interest at the rate of 1.81%.