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Homework answers / question archive / You are the owner of 100 bonds issued by Euler, Ltd
You are the owner of 100 bonds issued by Euler, Ltd. These bonds have 8 years remaining to maturity, an annual coupon payment of $80, and a par value of $1,000. Unfortunately, Euler is on the brink of bankruptcy. The creditors, including yourself, have agreed to a postponement of the next 4 interest payments (otherwise, the next interest payment would have been due in 1 year). The remaining interest payments, for Years 5 through 8, will be made as scheduled. The postponed payments will accrue interest at an annual rate of 6 percent, and they will then be paid as a lump sum at maturity 8 years hence. The required rate of return on these bonds, considering their substantial risk, is now 28 percent. What is the present value of each bond?
The present value is $266.88.
To solve, first find the compounded value at Year 8 of the postponed interest payments.
Future value of deferred interest = $80(1.06)^7 + $80(1.06)^6 + $80(1.06)^5 + $80(1.06)^4
= $441.83 payable at t = 8.
Then find the value of the bond considering all cash flows.
VB= $80(1/1.28)^5 + $80(1/1.28)^6 + $80(1/1.28)^7+ $80(1/1.28)^8 + $1,000(1/1.28)^8 + $441.83(1/1.28)^8 = $266.86.
