Question 6 (Total 15 marks) Wiki Limited is considering how to raise money for t

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Question 6 (Total 15 marks) Wiki Limited is considering how to raise money for the expansion of its operation. One option is to issue a new, 15-year bond. In order to estimate the cost of this method of financing, i.e. the YTM of the new bond, the company has the following information for reference: First, the company currently has an outstanding bond issue, with 8 year before maturity, which pays 10% annual coupon, and is currently traded at 117.914 (percent of par). Secondly, the relevant yield curve indicates that the YTM for a 15-year bond is higher than a 8 year-bond with the same rating by 296. (a) Find the YTM of the Wiki's currently outstanding bonds. (Hint: the required yield differs from the coupon rate of that bond by either 190, or 290, or 3%)(4 marks) (b) Suppose the new bond is also to pay 10% annual coupon, calculate the issue price of the bond (as percentage of par). (4 marks) (c) Explain why the yield of a 15-year bond should be higher than that of a bond of the same company with 8 years to maturity, supposing no change in the rate of inflation is expected for the foreseeable future. (4 marks) (d) Suppose further that the flotation cost will amount to 3% of total proceeds from this bond issue, what will be total market value of the new bonds to be issued in order to raise $4,656,000 for capital expansion project. (3 marks) 2 Answers for Question 6

Explanation / Answer

Par Value – 100

Current value – 117.914

Maturity – 8 Years ®

Coupon Rate – 10%

Coupon Payment – 100*10% = 10.

Formula for ytm:-

Current Value = Coupon Payment *{ 1-

i.e. 117.914 = 10* {1- 1/(1+i)^8}/i + 100 *{1/(1+i)^8

Thus, YTM – 11.26%

Par Value – 100

YTM – 11.26%

Int – 10%

Int Payment – 10

Issue price – Present value of bond + Present value of interest payment

Present value of Bond – 100 * 1/(1.1126)^8 = 42.588

Present value of Interest Payment – Annual Int Payment * Annuity factor for 11.26% for 8 years = 50.98

Thus, issue price = 42.588 + 50.98 = 93.568

Flotation Cost @ 3% - $4,656,000 *3% = $139,680

Total money - $4,795,680

Thus, total money to be raised is - $4,795,680.

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