The cost of debt: Dynamo Corporation has semiannual 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?

Question

Quizplus · Accepted Answer

First, we need to calculate the annual coupon payment: 
Annual coupon payment = Semiannual coupon rate * Face value 
Annual coupon payment = 0.08/2 * $1,000 = $40

Next, we need to calculate the yield to maturity (YTM) of the bond, which is the equivalent annual return (EAR) to the investor:

$1,080.29 = $40/(1 + YTM/2)^24 + $1,000/(1 + YTM/2)^24

Solving for YTM using a financial calculator or Excel, we get YTM = 7.12%. Therefore, the EAR is also 7.12%, which is closest to choice C (7.00%).

The Cost of Debt: Dynamo Corporation Has Semiannual Bonds Outstanding