Question

The company is currently focusing to expand its business units therefore it needs extra funds to purchase new assets. The company has already issued both preferred and common stock in the market. company is able to sell 18% preferred stock issue at Rs.100 par value and the required rate of return on this investment is 15%.

However the demand of company’s Common stock is increasing day by day in the market. The Company’s financial highlights show that it has announced Rs. 6 dividend on common stock this year. According to investor expectations it would grow at the rate of 5% for next 3 years, then at the rate of 6% for next 3 years and then at the rate of 7% thereafter. If required rate of return of investor is 14%.   

The company’s financial analysist has proposed the directors to issue Perpetual Bonds and Coupon Bonds to raise funds instead of taking loan from banks. For this purpose company is also analyzing that if Rs.1000 par value bond with coupon rate of 11% is issued in marker for maturity period of 14 years then what would be the current market price of bond keeping in view that investor’s required rate of return on this bond is 10%.

You are supposed to calculate value of this bond and also highlight difference between perpetual bond and coupon bond.

Answer 1

No of periods = 14 years

Coupon per period = Coupon rate * Par value

Coupon per period = 11% * $1000

Coupon per period = $110

Value of Coupon paying bond

Bond Price = Coupon / (1 + YTM)^period + Face value / (1 + YTM)^period

Bond Price = $110 / (1 + 10%)¹ + $110 / (1 + 10%)² + ...+ $110 / (1 + 10%)¹⁴ + $1,000 / (1 + 10%)¹⁴

Using PVIFA = ((1 - (1 + Interest rate)^{- no of periods}) / interest rate) to value coupons

Bond Price = $110 * (1 - (1 + 10%)^-14) / (10%) + $1,000 / (1 + 10%)¹⁴

Bond Price = $810.34 + $263.33

Bond Price = $1073.67

Perpetual Bond	Coupon Bond
The maturity of a perpetual bond is not fixed it is infinite.	The maturity of a coupon paying bond is fixed.
They are mostly issued by banks for capital reserve requirements.	They are issued by Sovereigns & Enterprises for specific purposes such as capital investments.
The required rate of return is usually higher with perpetual bonds since they have longer maturity.	The required rate of return depends on the maturity, default risk & liquidity but is usually lower than perpetual bonds.
These bonds continue paying a steady state of interest forever.	These bonds as specified may pay a fixed or floating coupon rate till the maturity date