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1) Two bonds have par values of $1,000
1) Two bonds have par values of $1,000.
One is a 6%, 17-year bond priced to yield 9.0%.
The other is a(n) 7%, 20-year bond priced to yield 4.5%.
Which of these two has the lower price? (Assume annual compounding in both cases.)
2) Project Salerino has the following cash flows: CF0 = -100, C01 = -290, C02 = 240, C03 = 570, C04 = -90. What is the FV of only the profits to Salerino if the cost of capital is 0.06?
Expert Solution
1) We can calculate the price of bond one by using the following formula in excel:-
=-pv(rate,nper,pmt,fv)
Here,
PV = Price of bond one
Rate = 9%
Nper = 17 periods
Pmt = Coupon payment = $1,000*6% = $60
FV = $1,000
Substituting the values in formula:
= -pv(9%,17,60,1000)
= $743.69
We can calculate the price of bond second by using the following formula in excel:-
=-pv(rate,nper,pmt,fv)
Here,
PV = Price of bond one
Rate = 4.5%
Nper = 20 periods
Pmt = Coupon payment = $1,000*7% = $70
FV = $1,000
Substituting the values in formula:
= -pv(4.5%,20,70,1000)
= $1,325.20
The 6%, 17-year bond has lower price of $743.69.
2) Computation of the FV only profits:-
FV = (C02*((1+cost of capital)^(4-2))) + (C03*((1+Cost of capital)^(4-3)))
= (240*((1+0.06)^(4-2))) + (570*((1+0.06)^(4-3)))
= 269.66 + 604.20
= 873.86
Note; Cash flows in year 2 and year 3 is positive and all are the cash flows is negative. So, we only use cash flow in year 2 and in year 3.
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