Question

6. (Ignore the drop down option all the infomration needed is available) Evaluating Annie Hegg's Proposed Investment in Atilier Industries Bonds Annie Hegg has been considering investing in the bonds of Atilier Industries. The bonds were issued 5 years ago at their $1,000 par value and have exactly 25 years remaining until they mature. They have an 8.0% coupon interest rate, are convertible into 50 shares of common stock, and can be called any time at $1,080.00. The bond is rated Aa by Moody's. Atilier Industries, a manufacturer of sporting goods, recently acquired a small athletic-wear company that was in financial distress. As a result of the acquisition, Moody's and other rating agencies are considering a rating change for Atilier bonds. Recent economic data suggest that expected inflation, currently at 5.0% annually, is likely to increase to a 6.0% annual rate. Annie remains interested in the Atilier bond but is concerned about inflation, a potential rating change, and maturity risk. To get a feel for the potential impact of these factors on the bond value, she decided to apply the valuation techniques she learned in her finance course. To Do a. If the price of the common stock into which the bond is convertible rises to $30.00 per share after 5 years and the issuer calls the bonds at $1,080.00, should Annie let the bond be called away from her or should she convert it into common stock? b. For each of the following required returns, calculate the bond's value, assuming annual interest. Indicate whether the bond will sell at a discount, at a premium, or at par value. (1) Required return is 6.0%. (2) Required return is 8.0%. (3) Required return is 10.0%. c. Repeat the calculations in part (b), assuming that interest is paid semiannually and that the semiannual required returns are one-half of those shown. Compare and discuss differences between the bond values for each required return calculated here and in part (b) under the annual versus semiannual payment assumptions. d. If Annie strongly believes that expected inflation will rise by 1.0% during the next few months, what is the most she should pay for the bond, assuming annual interest? e. If the Atilier bonds are downrated by Moody's from Aa to A, and if such a rating change will result in an increase in the required return from 8.0% to 8.75%, what impact will this have on the bond value, assuming annual interest? f. If Annie buys the bond today at its $1,000 par value and holds it for exactly 3 years, at which time the required return is 7.0%, how much of a gain or loss will she experience in the value of the bond (ignoring interest already received and assuming annual interest)? g. Rework part (f), assuming that Annie holds the bond for 10 years and sells it when the required return is 7.0%. Compare your finding to that in part (f), and comment on the bond's maturity risk. h. Assume that Annie buys the bond at its current price of $983.80 and holds it until maturity. What will her current yield and yield to maturity (YTM) be, assuming annual interest? i. After evaluating all of the issues raised above, what recommendation would you give Annie with regard to her proposed investment in the Atilier Industries bonds? a. If the price of the common stock into which the bond is convertible rises to $30.00 per share after 5 years and the issuer calls the bonds at $1,080.00, should Annie let the bond be called away from her or should she convert it into common stock? The value of the stock if the bond is converted is $ . (Round to the nearest cent.) (Select the best choice below.) A. Annie should not convert the bonds because the value of the shares is $1,500.00 > $1,080.00. B. Annie should convert the bonds because the value of the shares is $1,500.00 > $1,080.00. C. Annie should convert the bonds because the value of the shares is $1,500.00 < $1,080.00. D. Annie should not convert the bonds because the value of the shares is $1,500.00 < $1,080.00. b. For each of the following required returns, calculate the bond's value, assuming annual interest. Indicate whether the bond will sell at a discount, at a premium, or at par value. (1) Required return is 6.0%. The bond's value will be $ . (Round to the nearest cent.) The bond would selling at (1) . (Select from the drop-down menu.) (2) Required return is 8.0%. The bond's value will be $ . (Round to the nearest cent.) The bond would selling at (2) . (Select from the drop-down menu.) (3) Required return is 10.0%. The bond's value will be $ The bond would selling at (3) . (Select from the drop-down menu.) c. Repeat the calculations in part (b), assuming that interest is paid semiannually and that the semiannual required returns are one-half of those shown. Compare and discuss differences between the bond values for each required return calculated here and in part (b) under the annual versus semiannual payment assumptions. . (Round to the nearest cent.) (1) Required return is 6.0%. The bond's value will be $ . (Round to the nearest cent.) The bond would selling at (4) . (Select from the drop-down menu.) (2) Required return is 8.0%. The bond's value will be $ . (Round to the nearest cent.) The bond would selling at (5) . (Select from the drop-down menu.) (3) Required return is 10.0%. The bond's value will be $ . (Round to the nearest cent.) The bond would selling at (6) . (Select from the drop-down menu.) (Select all the choices that apply.) A. Under all three required returns for annual interest payments the bonds are consistently priced higher than for semiannual interest payments. B. When the required return is above (below) the coupon the bond sells at a discount (premium). When the required return and coupon are equal the bond sells at par. C. Under all three required returns for both annual and semiannual interest payments the bonds are consistent in their direction of pricing. D. When the change is made from annual to semiannual payments the value of the premium bond increases and the value of the par bond stays the same while the value of the discount bond decreases. This difference is due to the higher effective return associated with more frequent compounding. d. If Annie strongly believes that expected inflation will rise by 1.0% during the next few months, what is the most she should pay for the bond, assuming annual interest? The bond's value will be $ . (Round to the nearest cent.) (Select the best choice below.) A. The bond price would drop to $818.46. This amount is the maximum Annie should pay for the bond. B. The bond price would drop to $817.44. This amount is the maximum Annie should pay for the bond. C. The bond price would drop to $901.77. This amount is the maximum Annie should pay for the bond. D. The bond price would drop to $924.81. This amount is the maximum Annie should pay for the bond. e. If the Atilier bonds are downrated by Moody's from Aa to A, and if such a rating change will result in an increase in the required return from 8.0% to 8.75%, what impact will this have on the bond value, assuming annual interest? The bond's value will be $ . (Round to the nearest cent.) (Select the best choice below.) A. The value of the bond would decline to $901.77 due to the higher required return and the inverse relationship between bond yields and bond values. B. The value of the bond would decline to $818.46 due to the higher required return and the inverse relationship between bond yields and bond values. C. The value of the bond would decline to $924.81 due to the higher required return and the inverse relationship between bond yields and bond values. D. The value of the bond would decline to $817.44 due to the higher required return and the inverse relationship between bond yields and bond values. f. If Annie buys the bond today at its $1,000 par value and holds it for exactly 3 years, at which time the required return is 7.0%, how much of a gain or loss will she experience in the value of the bond (ignoring interest already received and assuming annual interest)? The bond's value will be $ . (Round to the nearest cent.) (Select the best choice below.) A. The bond would increase in value and Annie would earn $120.61. B. The bond would increase in value and Annie would earn $110.61. C. The bond would increase in value and Annie would earn $91.08. D. The bond would increase in value and Annie would earn $130.61. g. Rework part (f), assuming that Annie holds the bond for 10 years and sells it when the required return is 7.0%. Compare your finding to that in part (f), and comment on the bond's maturity risk. The bond's value will be $ . (Round to the nearest cent.) (Select the best choice below.) A. The bond would increase in value and Annie would earn a gain of $130.61. The bond has a smaller reaction to yield changes as the maturity shortens. B. The bond would increase in value and Annie would earn a gain of $110.61. The bond has a smaller reaction to yield changes as the maturity shortens. C. The bond would increase in value and Annie would earn a gain of $91.08. The bond has a smaller reaction to yield changes as the maturity shortens. D. The bond would increase in value and Annie would earn a gain of $120.61. The bond has a smaller reaction to yield changes as the maturity shortens. h. Assume that Annie buys the bond at its current price of $983.80 and holds it until maturity. What will her current yield and yield to maturity (YTM) be, assuming annual interest? The yield to maturity will be %. (Round to two decimal places.) i. After evaluating all of the issues raised above, what recommendation would you give Annie with regard to her proposed investment in the Atilier Industries bonds? (Select from the drop-down menu and slect all the choices that apply.) Annie (7) invest in the Atilier bond. There are several reasons for this conclusion. A. An increase in interest rates is likely due to the possibility of higher inflation thus driving the price down. B. The term to maturity is long and thus the maturity risk is high. C. An increase in interest rates is likely due to the potential downgrading of the bond thus driving the price down. D. The price of $983.80 is well above her minimum price of $901.77 assuming an increase in interest rates of 1.0%. (1) a premium (2) a discount par value (6) a premium (7) a discount par value a premium (3) a discount par value should probably not should probably a premium (4) a discount par value a premium (5) a discount par value a premium a discount par value

Answer 1

Part A

Annie should convert the bonds. The value of the stock if the bond is converted is: 50 shares × $30 per share = $1,500 while if the bond was allowed to be called in the value would be on $1,080

Part B

Current value of bond under different required returns – annual interest

a. B0 = I × (PVIFA6%,25 yrs.) + M × (PVIF6%,25 yrs.)

B0 = $80 × (12.783) + $1,000 × (0.233)

B0 = $1,022.64 + $233 B0 = $1,255.64

Calculator solution: $1,255.67

The bond would be at a premium.

b. B0 = I × (PVIFA8%,25 yrs.) + M × (PVIF8%,25 yrs.)

B0 = $80 × (10.674) + $1,000 × (0.146)

B0 = $853.92 + $146 B0 = $999.92

Calculator solution: $1,000.00

The bond would be at par value.

c. B0 = I × (PVIFA10%,25 yrs.) + M × (PVIF10%,25 yrs.)

B0 = $80 × (9.077) + $1,000 × (0.092)

B0 = $726.16 + $92 B0 = $818.16

Calculator solution: $818.46 The bond would be at a discount.

Part C

3. Current value of bond under different required returns – semiannual interest

a. B0 = I × (PVIFA3%,50 yrs.) + M × (PVIF3%,50 yrs.)

B0 = $40 × (25.730) + $1,000 × (0.228)

B0 = $1,029.20 + $228 B0 = $1,257.20

Calculator solution: $1,257.30 The bond would be at a premium.

b. B0 = I × (PVIFA4%,50 yrs.) + M × (PVI4%,50 yrs.)

B0 = $40 × (21.482) + $1,000 × (0.141)

B0 = $859.28 + $146 B0 = $1005.28

Calculator solution: $1,000.00

The bond would be at par value.

c. B0 = I × (PVIFA5%,50 yrs.) + M × (PVIF5%,50 yrs.)

B0 = $40 × (18.256) + $1,000 × (0.087)

B0 = $730.24 + $87 B0 = $817.24

Calculator solution: $817.44 The bond would be at a discount.

Part D

If expected inflation increases by 1% the required return will increase from 8% to 9%, and the bond price would drop to $901.84.

This amount is the maximum Annie should pay for the bond.

B0 = I × (PVIFA9%,25 yrs.) + M × (PVIF9%,25 yrs.)

B0 = $80 × (9.823) + $1,000 × (0.116)

B0 = $785.84 + $116 B0 = $901.84

Calculator solution: $901.77

An expert here is allowed to answer initial 4 qtns. Please repost for the rest. Thanks