question archive Tom Cruise Lines Inc
Tom Cruise Lines Inc
Subject:FinancePrice:2.86 Bought11
Tom Cruise Lines Inc. issued bonds five years ago at $1,000 per bond. These bonds had a 25-year life when issued and the annual interest payment was then 12 percent. This return was in line with the required returns by bondholders at that point as described below:
Real rate of return3%Inflation premium4 Risk premium5 Total return12%
Assume that five years later the inflation premium is only 3 percent and is appropriately reflected in the required return (or yield to maturity) of the bonds. The bonds have 20 years remaining until maturity.
What is the new price of the bond?
Purchase A New Answer
Custom new solution created by our subject matter experts
GET A QUOTE
Answer Preview
New price of the bond=$1079.63
Step-by-step explanation
Yield after 5 years of the issue= Real rate+Inflation premium+risk premium
= 3%+3%+5%
=11%
Coupon amount=12%*1000=120
Par value= FV=1000
N=25-5= 20 years
New price of the bond= PV of coupon + PV of par value
= Coupon*(1-1/(1+r)^n)/r+ FV/(1+r)^n
=120*(1-1/(1+11%)^20)/11%+ 1000/(1+11%)^20
=120*7.963328117+ 1000/8.062311536
=955.5993741+124.0339071
=1079.63
(Excel formula for finding the bond price is =-pv(11%,20,120,1000))
