BDJ Co. wants to issue new 25-year bonds for some much-needed expansion projects
ID: 2379638 • Letter: B
Question
BDJ Co. wants to issue new 25-year bonds for some much-needed expansion projects. The company currently has 7.8 percent coupon bonds on the market that sell for $1,125, make semiannual payments, and mature in 20 years.
What coupon rate should the company set on its new bonds if it wants them to sell at par?
BDJ Co. wants to issue new 25-year bonds for some much-needed expansion projects. The company currently has 7.8 percent coupon bonds on the market that sell for $1,125, make semiannual payments, and mature in 20 years.
Explanation / Answer
The yield to maturity on the current bonds can be calculated as follows
Semiannual coupon = 0.078 / 2 * 1000 = $39
Cash flows are as follows
Periods 1 to 49 = $39 (n = 25*2 = 50)
Period 50 = 1039
Period 0 = present value of the bond = -1125
Use the calculator to enter these cash flows, and then compute the IRR
You should get 3.55%. This is a semiannual rate. Hence the YTM on the bond = 3.65 * 2 = 7.1%
The new bond should be issued at 7.10% if it is to be sold at par since this is the required return on a similar bond.
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