The cost of debt: Dynamo company has bonds outstanding with 12 years to maturity and are currently priced at $1,080.29. If the bonds have a coupon rate of 8 percent, then what is the equivalent annual return (EAR) to the investor for purchasing the bonds at the described price? (Semiannual interest)
A) 3.5%
B) 7.00%
C) 7.12%
D) 8.00%

Question

Quizplus · Accepted Answer

To calculate the EAR, we need to first find the bond's yield-to-maturity (YTM). We can use a financial calculator, such as the Texas Instruments BA II Plus or an Excel spreadsheet, to solve for the YTM. Alternatively, we can use an online bond calculator.

Using a financial calculator:

N = 24 (12 years x 2 semiannual periods per year)
PV = -1080.29 (negative because it represents a cash outflow)
PMT = 40 (8% coupon rate / 2 semiannual periods)
FV = 1000 (principal value at maturity)
CPT -> I/Y = 3.56%

Using an online bond calculator:
https://www.calculator.net/bond-calculator.html
Inputs:
Bond price: 1080.29
Face value: 1000
Coupon rate: 8%
Years to maturity: 12
Coupon frequency: Semi-Annual

Output: Yield-to-Maturity (IRR) = 3.56%

Therefore, the EAR is:

EAR = (1 + YTM/2)^2 - 1
EAR = (1 + 0.0356/2)^2 - 1
EAR = 7.12%

So, the best choice is C.

The Cost of Debt: Dynamo Company Has Bonds Outstanding with 12