An investor pays $900 for a bond with a principal value of $1,000 and a coupon rate of 8%. How much in annual interest will the
1 answer:
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Answer:
To evaluate the choice, we have to calculate the present value of future cash flows and compare it with the cost. We use the following formula
present value = C × [ ]
where
C = yearly payments = 75000
i = interest rate = 8%
n = no. of years = 15
put the given values in above equation, we get
Present value = 75000 ×8.559478688
= 641,961
Since the present value of cash flow 641,961 is less than the cost 750,000, I would not recommend it.
If Interest rate = 5%, then:
Do the same procedure as above but take i=5%
Present value = 75000 × 10.37965804
= 778,474
Since the present value of future cash flows 778,474 is greater than the cost 750,000, I would recommend it.