Determine the present value of the bond's cash flows if the required rate of return is 16.64 percent. How would it change if the required rate of return is 12.36 percent?
If a corporation has also issued bonds which have a face value of $1,000, will mature in 10 years, and carry a coupon rate of 16 percent. Assume interest payments are made semiannually.
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The bonds issued by the corporation have a face value of $1000 and the coupon rate is 16% payable semi-annually. The coupons mature after a period of 10 years.
The present value of an amount A due after n years if the expected rate of return is r is given by A/(1 + r)^n
For a required rate of return is 16.64%, the present value of the bond's cash flows can be calculated as follows. The semiannual rate of return is 8.32%. The face value $1000 is due after 20 periods and $80 are due for 10 years after 6 months. The present value of the cash flows which is the sum of the all the cash flows discounted appropriately is:
1000/(1.0832)^20 + 80/(1.0832)^20 + 80/(1.0832)^19 +...80/(1.0832)^1 = $969.31
If the required rate of return is 12.36%, the present value of the cash flows is:
1000/(1.0618)^20 + 80/(1.0618)^20 + 80/(1.0618)^19 +...80/(1.0618)^1 = $1205.02
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