Question 1 Mel Meyers International Inc. has a series of $1,000 par value bonds outstanding....

Question 1

Mel Meyers International Inc. has a series of $1,000 par value bonds outstanding. Each bond pays interest quarterly and carries a coupon rate of 8%. Some bonds are due in 6 years while others are due in 10 years.

Required:

If the required rate of return on bonds is 10%, what is the current price of the bonds with 6 years to maturity?
If the required rate of return on bonds is 4%, what is the current price of the bonds with 10 years to maturity?
Briefly but concisely explain the results of your calculations in part (A) and (B) above.

Question 2

What options do small businesses have for raising capital? How does small business cost of capital compare to the cost of capital for a large business? Briefly and concisely explain.

Solutions

Expert Solution

1: a

Using financial calculator

Input: FV= 1000, N = 6*4 = 24, I/Y = 10/4 = 2.5 , PMT = 8%*1000/4 = 20

Solve for PV as $910.58

Using financial calculator

Input: FV= 1000, N = 10*4 = 40, I/Y = 4/4 =1 , PMT = 8%*1000/4 = 20

Solve for PV as 1328.35

C: We see that the required rate of return is inversely proportional to the price. As the required rate increases, the price decreases and vice versa. Also, the term of maturity is directly proportional to the price. Longer the term, higher will be the risk and so higher will be the price.

Q2: Small businesses have limited options for raising funds. They rely on personal funds and finances from known people for raising funds. These are loans at a higher rate of interest due to greater risk to the lender. Thus they have greater cost of capital due to lower credit standing.

A larger business has a lower cost of capital since it has greater credit standing. Also it has access to huge amount of funds in the equity market and bond market. Financial institutions also lend at a lower rate due to greater negotiating power of the business.

jeff jeffy answered 2 weeks ago

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