Question

Permian Underground Machines & Pipes Co. (PUMP) is in the oil and gas equipment and services industry. It is considering a new oilfield services operation in the Permian Basin. This project would require an outlay of $50 million.
Suppose that PUMP hires Moody’s to assess the company’s credit quality if it were to issue the bonds. Moody’s advises PUMP that it would rate its bonds as Caa.

Managers at PUMP consider issuing a 20-year bond. Currently, the yield on a U.S. Treasury bond with about 20 years to maturity is 1.81%.

Estimate the required rate of return for the bond that PUMP managers are considering.

a. 9.30%
b. 12.44%
c. 18.71%
d. 2.28%
e. 1.81%

Answer 1

Answer:

b. 12.44%

Explanation:

The Permian Underground Machines & Pipes Co. (PUMP) is considering to pursue a new oilfield services operation which will require an investment of $50 million. The company requires to borrow funds by issuance of bonds with 20 years of maturity. The moody's has assessed the company project to be risky and has rated it as Caa. The Caa rating is considered to be vulnerable and ability for the project to meet its financial obligations depends on its favorable business outcome and good economic conditions.