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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?
Expert Solution
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.
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