Question

A company needs to raise $22 million and plans to issue 20-year bonds for this purpose. The required rate of return is 7.6 percent in the current market. The company has two issue alternatives: a 7.6 percent coupon and a zero coupon bond. The company's tax rate is 34 percent. At bond maturity, how much will the company need to pay to its bondholders if it issues the coupon bonds? What if it issue the zeros? Assume semiannual compounding for both bond issues. (For simplicity's sake, assume the company can issue a partial bond.)

Answer 1

Answer and Explanation:

The computation is shown below:

Since the required rate of return equal to the coupon rate i.e 7.6% that means the bond issued at par

Therefore, the number of bond issued is

We assume the par value is $1,000

=$22,000,000 ÷ $1,000

= 22,000 Coupon bonds

And  

Price of zero Coupon bond is

= $1,000 × (1.038)^-40

= $224.96

And, Number of coupon bond is

= 22,000,000 ÷ $224.96

= 97,795 zero Coupon bond

Now the payment made to bondholders in case of issuing the coupon bond is

= (Last Coupon payment + face value) × number of bond

= (1000 + 36) ×22,000

= $22,836,000 or 22.836 million

And in case of issuance of the zero coupon bond, the payment is

= Number of bonds × face value

= 97,795 × 1000

= 97,795,000 or 97.795 million

The time period doubles and the rate is half