Problem 10-13 Effect of yield to maturity on bond price [LO3] Tom Cruise Lines I
ID: 2721042 • Letter: P
Question
Problem 10-13 Effect of yield to maturity on bond price [LO3] Tom Cruise Lines Inc. issued bonds five years ago at $1,000 per bond. These bonds had a 30-year life when issued and the annual interest payment was then 15 percent. This return was in line with the required returns by bondholders at that point as described below: Real rate of return 5 % Inflation premium 5 Risk premium 5 Total return 15 % 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 25 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.) New price of the bond $ References
Explanation / Answer
Answer
New required rate of return = Real rate of return + Inflation premium + Risk premium
=5% + 3% + 5%
=13%
Figures in $
Year
Interest
Principal
Cash
flow
Disc Rate : 13%
Present value
A
B
C
D
A+B
C*D
1
150
150
0.88
132.74
2
150
150
0.78
117.47
3
150
150
0.69
103.96
4
150
150
0.61
92.00
5
150
150
0.54
81.41
6
150
150
0.48
72.05
7
150
150
0.43
63.76
8
150
150
0.38
56.42
9
150
150
0.33
49.93
10
150
150
0.29
44.19
11
150
150
0.26
39.10
12
150
150
0.23
34.61
13
150
150
0.20
30.62
14
150
150
0.18
27.10
15
150
150
0.16
23.98
16
150
150
0.14
21.22
17
150
150
0.13
18.78
18
150
150
0.11
16.62
19
150
150
0.10
14.71
20
150
150
0.09
13.02
21
150
150
0.08
11.52
22
150
150
0.07
10.19
23
150
150
0.06
9.02
24
150
150
0.05
7.98
25
150
1000
1150
0.05
54.17
Net present value
1146.6
Answer : The new price of the bond is $ 1146.60
Figures in $
Year
Interest
Principal
Cash
flow
Disc Rate : 13%
Present value
A
B
C
D
A+B
C*D
1
150
150
0.88
132.74
2
150
150
0.78
117.47
3
150
150
0.69
103.96
4
150
150
0.61
92.00
5
150
150
0.54
81.41
6
150
150
0.48
72.05
7
150
150
0.43
63.76
8
150
150
0.38
56.42
9
150
150
0.33
49.93
10
150
150
0.29
44.19
11
150
150
0.26
39.10
12
150
150
0.23
34.61
13
150
150
0.20
30.62
14
150
150
0.18
27.10
15
150
150
0.16
23.98
16
150
150
0.14
21.22
17
150
150
0.13
18.78
18
150
150
0.11
16.62
19
150
150
0.10
14.71
20
150
150
0.09
13.02
21
150
150
0.08
11.52
22
150
150
0.07
10.19
23
150
150
0.06
9.02
24
150
150
0.05
7.98
25
150
1000
1150
0.05
54.17
Net present value
1146.6
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