A company wishes to issue $600,000 of 10-year, 6.8% bonds, with interest paid annually at the end of the year. The market rate of interest is currently 5%. What information is needed in order to determine the selling price?

Question

Quizplus · Accepted Answer

To determine the selling price of the bonds, we need to calculate the present value of the future cash flows that the bonds will generate. These cash flows consist of the annual interest payments and the repayment of the principal at maturity. The present value of these cash flows is determined by discounting them at the market rate of interest.
The information needed to calculate the selling price of the bonds includes:
- The face value of the bonds: This is the principal amount that the company will repay at the end of the bond term. In this case, it is $600,000.
- The stated rate of interest (coupon rate): This is the rate at which the company will pay interest to the bondholders. It is given as 6.8%.
- The market rate of interest (yield to maturity): This is the rate at which the market is willing to lend money. It is given as 5%.
- The bond life (term or maturity): This is the duration until the bonds mature, which is 10 years in this case.
The bond rating and the purpose of the issue are not required to calculate the selling price of the bonds. The bond rating could affect the market rate of interest if it wasn't already provided, as it indicates the creditworthiness of the issuer and therefore the risk associated with the bond. However, since the market rate of interest is already given, the bond rating is not necessary for this calculation. The purpose of the issue is also not relevant to the calculation of the selling price.
Therefore, the correct information needed is:
b. The face value of the bonds, the stated rate of interest, the market rate of interest, and the bond life.
Using this information, the selling price of the bonds can be calculated by discounting the annual interest payments and the face value at the market rate of interest over the bond life. The sum of the present value of the interest payments and the present value of the face value will give us the selling price of the bonds.

A Company Wishes to Issue $600,000 of 10-Year, 6