Stanovich Enterprises has 10-year, 12.0% semiannual coupon bonds outstanding.Each bond is now eligible to be called at a call price of $1,060.If the bonds are called, the company must replace them with new 10-year bonds.The flotation cost of issuing new bonds is estimated to be $45 per bond.How low would the yield to maturity on the new bonds have to be in order for it to be profitable to call the bonds today, i.e., what is the nominal annual "breakeven rate"?

Question

Quizplus · Accepted Answer

First, we need to calculate the current price of the bond. We can use the following formula:

Bond price = (Coupon payment / (1 + Yield)^Time) + [(Face value / (1 + Yield)^Time]

Where:
Coupon payment = (12% / 2) x $1,000 = $60
Yield = Yield to maturity / 2 (since it is a semi-annual bond)
Time = 20 (since there are 20 periods - 10 years x 2 semi-annual periods per year)

Using a financial calculator or Excel, we can find that the bond price is currently $1,133.30.

Next, we need to calculate the cost of calling the bond. Since the call price is $1,060, we need to pay a premium of $1,133.30 - $1,060 = $73.30 per bond.

The company also incurs a flotation cost of $45 per bond when issuing new bonds.

So, the total cost of calling and issuing new bonds is:
$73.30 + $45 = $118.30 per bond.

Now we can calculate the breakeven yield to maturity on the new bonds. We can use the following formula:

Breakeven yield = Coupon rate + [(Call price - Current price + Flotation cost) / ((Call price + Current price) / 2)]

Plugging in the numbers, we get:

Breakeven yield = 12% + [($1,060 - $1,133.30 + $45) / (($1,060 + $1,133.30) / 2)] / 2
Breakeven yield = 10.29%

Therefore, the answer is C) 10.29%.

Stanovich Enterprises Has 10-Year, 12