Tom Cruise Lines Inc. issued bonds five years ago at $1,000 per bond. These bond
ID: 2766171 • Letter: T
Question
Tom Cruise Lines Inc. issued bonds five years ago at $1,000 per bond. These bonds had a 25-year life when issued and the annual interest payment was then 13 percent. This return was in line with the required returns by bondholders at that point as described below:
Assume that five years later the inflation premium is only 3 percent and is appropriately reflected in the required return (or yield to maturity) of the bonds. The bonds have 20 years remaining until maturity.
Compute the new price of the bond. Use Appendix B and Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods. (Do not round intermediate calculations. Round your final answer to 2 decimal places. Assume interest payments are annual.)
Explanation / Answer
Answer
Yield to maturity = Real rate of return + Inflation premium + Risk premium
= 4% + 3% + 4%
= 11%
Figures in $
Year
Interest payment
Redemption price
Cash flow
Disc Rate : 11%
Present value
A
B
C
D
A+B
C*D
1000*0.13
1
130
130
0.90
117.12
2
130
130
0.81
105.51
3
130
130
0.73
95.05
4
130
130
0.66
85.64
5
130
130
0.59
77.15
6
130
130
0.53
69.50
7
130
130
0.48
62.62
8
130
130
0.43
56.41
9
130
130
0.39
50.82
10
130
130
0.35
45.78
11
130
130
0.32
41.25
12
130
130
0.29
37.16
13
130
130
0.26
33.48
14
130
130
0.23
30.16
15
130
130
0.21
27.17
16
130
130
0.19
24.48
17
130
130
0.17
22.05
18
130
130
0.15
19.87
19
130
130
0.14
17.90
20
130
1000
1130
0.12
140.16
Present value
1159.27
Answer : New price of the bond is $ 1159.27
Figures in $
Year
Interest payment
Redemption price
Cash flow
Disc Rate : 11%
Present value
A
B
C
D
A+B
C*D
1000*0.13
1
130
130
0.90
117.12
2
130
130
0.81
105.51
3
130
130
0.73
95.05
4
130
130
0.66
85.64
5
130
130
0.59
77.15
6
130
130
0.53
69.50
7
130
130
0.48
62.62
8
130
130
0.43
56.41
9
130
130
0.39
50.82
10
130
130
0.35
45.78
11
130
130
0.32
41.25
12
130
130
0.29
37.16
13
130
130
0.26
33.48
14
130
130
0.23
30.16
15
130
130
0.21
27.17
16
130
130
0.19
24.48
17
130
130
0.17
22.05
18
130
130
0.15
19.87
19
130
130
0.14
17.90
20
130
1000
1130
0.12
140.16
Present value
1159.27