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1) Discuss why companies decide to issue bonds as a source of finance

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1)

1. Discuss why companies decide to issue bonds as a source of finance. (1 mark)
2. Explain why bond prices have an inverse relationship with interest rate movements. ( 1 mark)

Albert Page purchased one of Extra-large Shirt Company’s bonds last year when the market interest rate on similar-risk bonds was 6 percent.   When he purchased the bond, it had seven years remaining until maturity. The bond’s coupon rate of interest (paid semi-annually) is 5 percent and its maturity value is $1000. Today, the market rate on similar risk bonds as the one Albert purchased one year ago is 4 percent.

3. If he were to sell the bond today, what price he can sell it for?

2)

Sigma Investment Ltd (SIL) is a provider of computer software and information technology services in two large regions of South East Asia, where its two divisions are located. The company uses a market rate of 11% to evaluate investments; however, based on recent management reports, it realized that the two divisions have a quite different risk and return profiles. In fact, comparable companies for division 1 have equity betas of 1.5 while for companies in division 2 it is about 0.5. The financial manager aims to estimate the cost of capital as precisely as possible and tries to evaluate how acceptable investments in both divisions are at an 11 percent rate.

The following data is available for both divisions:

1. Estimate the weighted average cost of capital (WACC) for both divisions.
2. Are both these divisions being a viable investment? Why and why not?