Question

On February 2nd, 2017, Apple (AAPL) Corporation issued a senior, unsecured bond with a maturity in 2047. The coupon rate on the new bond is 4.25% fixed paying semi-annual interest on February 9th and August 9th. At the time of issue the bond received a AA+ rating from Standard & Poor's and Aa1 rating from Moody's. The amount raised through this bond issue was $1 billion. In the first quarter of 2017, Apple saw a net income growth rate of 4.88% reflecting a new profit margin of 20.85%. In May 2017, Apple announced an increase in share buy backs from $175 billion to $210 billion and 10.5% dividend increase from $0.57 to $0.63. The bond does not have any protective covenants. The call feature is structured in such a way making a call not very likely at this time.

a-1: If today, a bondholder's required rate of return for Apple's bond is 5.15%, find the intrinsic value for the bond. Show your calculator keystroke variables used to solve for the intrinsic value.

a-2: Given the information in part a, would this bond sell at a discount or a premium?  Explain your answer.

a-3: If Apple's bond is today quoted at 89, should the investor purchase the bond today?  Explain your answer.

b-1: If today, a different bondholder's required rate of return for Apple's bond is 3.15%, find the intrinsic value for the bond. Show your calculator keystroke variables used to solve for the intrinsic value.

b-2: Given the information in part b, would this bond sell at a discount or a premium?  Explain your answer.  

b-3: If Apple's bond is today quoted at 118.4, should the investor purchase the bond today?  Explain your answer.

c. Which required rate of return (5.15% or 3.15%) is most likely to be a correct required rate of return in today's bond market?  Justify your answer.

Answer 1

A - 1 Bonds intrinsic value / present value is $ 88.85.

Calculator Keystroke:

Step

1) Empty calculator memory

2) Rate of return is 5.15% p.a and coupon payment is semi annual divide rate of Return of 5.15% by 2 you will get 2.575% or 0.02575

3) Divide 1 / (1+ 0.02575) and press “ = “ for 40 times and note down last 40^th value ( coupon payment during the tenure of bond is 40 times till maturity)

4) Now you press GT / Memory on your calculator you will get cumulative figure multiply it with 2.13   (100 x 4.25% x 1/2) and Maturity value of 100 last 40^th value 0.36169 and finally take sum of all multiplied value to get present value / Intrinsic value.

A – 2 Since Bonds intrinsic value / present value is $ 88.85 which is lower than Face value of bonds which is $ 100. Therefore bonds is trading at discount to face value

A - 3 Since Present value / Intrinsic value is $ 88.85 at yield to maturity (YTM) /rate of return at 5.15% ( Investor Expected rate of return) and prices quoted by Apple is $ 89. Investor should not purchase the bond as it result in decrease in rate of return below 5.15%.

B- 1 Bonds intrinsic value / present value is $ 116.23.

Calculator Keystroke: Please follow similar step as given above

B – 2 Since Bonds intrinsic value / present value is $ 116.23 which is higher than Face value of bonds which is $ 100. Therefore bonds is trading at Premium to face value.

B – 3 Since Present value / Intrinsic value is $ 116.23 at yield to maturity (YTM) /rate of return at 3.15% ( Investor Expected rate of return) and prices quoted by Apple is $ 118.4. Investor should not purchase the bond as it result in decrease in rate of return below 3.15%.

C As Apple announces in share buyback , increased in amount of dividend and better Net profit margin of 20.85% showing fundamentally strong and cash rich company therefore price of bonds such financially strong company should be trading at premium in market and therefore correct rate of return for investor in current market environment would be 3.15% p.a .