Suburbia plans to issue bonds to finance $3,000,000 construction. The town pays

Question

Suburbia plans to issue bonds to finance $3,000,000 construction. The town pays for its capital projects on pay-as-you-go basis. Suburbia has approved issuance of 10-year bonds with the coupon rate of 2.5% (this annual rate is compounded semi-annually). Calculate the potential price of the Suburbia bonds, using market rates of 3% and 1.5%. Make sure to use both the level debt service and level principal schedules for bond price calculations. Which types of bonds would you recommend to issue and why? (This assumes that both are available to the city, which is not the case.) Are there other financing options you may recommend? (You are allowed to use the MA Department of Revenue debt service calculator as long as you will remember to enter all items correctly.)

Explanation / Answer

Present value of bonds at 3% market Rate Present value of semiannual payment = $3,000,000 x 2.5%/2 x PVIFA(1.5%,20)= $3,000,000 x 17.169 $643,837.5 Present value of Principal $3,000,000 x PV(1.5%,20) = $3,000,000 x .7425 $2,227,500 Present value of Bonds at 3% market Rate $2,871,337.5 Present value of bonds at 1.5% market Rate Present value of semiannual payment = $3,000,000 x 2.5%/2 x PVIFA(.75%,20)= $3,000,000 x 18.508 $694,050 Present value of Principal $3,000,000 x PV(.75%,20) = $3,000,000 x .8612 $2,583,600 Present value of Bonds at 1.5% market Rate $3,277,650 The bond issued at 3% market rate is issued at discount and bond issued at 1.5% market rate is issued at premium. The bond issued at semiannual payment but its price fluctuates with the change in a prevailing interest rates. The company should think of issuing bonds at discount because the company has to make lower coupon payment and secondly it depends upon market interest rate if rates are rising results in a greater percentage of bonds trading at a discount.

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