GP&L sold $1,000,000 of 12 percent, 30-year, semiannual payment bonds 15 years ago. The bonds are not callable, but they do have a sinking fund which requires GP&L to redeem 5 percent of the original face value of the issue each year ($50,000), beginning in Year 11. To date, 25 percent of the issue has been retired. The company can either call bonds at par for sinking fund purposes or purchase bonds in the open market, spending sufficient money to redeem 5 percent of the original face value each year. If the yield to maturity (15 years remaining) on the bonds is currently 14 percent, what is the least amount of money GP&L must put in to satisfy the sinking fund provision? (Round the answer to the nearest whole number.)

Question

Quizplus · Accepted Answer

To satisfy the sinking fund provision, GP&L needs to redeem 5% of the original face value of the issue each year, which is $50,000. Since 25% of the issue has been retired, the remaining amount to be redeemed each year is 5% x 75% x $1,000,000 = $37,500.

GP&L can either call bonds at par for sinking fund purposes or purchase bonds in the open market. Since the yield to maturity on the bonds is currently 14%, it is more expensive to call the bonds at par because they would have to be called at a premium to the par value. Therefore, GP&L should purchase bonds in the open market.

The least amount of money GP&L must put in to satisfy the sinking fund provision is the amount required to purchase bonds with a total face value of $37,500 at a yield to maturity of 14% and 15 years remaining. Using a financial calculator, the present value of this annuity is $43,796. Therefore, the answer is D, $43,796.

GP&L Sold $1,000,000 of 12 Percent, 30-Year, Semiannual Payment Bonds