Question

Rodomontade is an investment firm specialising in corporate advice, particularly in regard to raising finance and company valuation. One of its clients, Donald Rump, the CEO of Rump Industries Ltd, has approached Rodomontade seeking advice and assistance. Question 1 Rump Industries Ltd is a large company listed on The Bahamas Stock Exchange. It is a diversified company with manufacturing and trading divisions operating in a number of industries. Rump has recently developed a new product which is the first of its kind and which is expected to make a significant contribution to the company’s future earnings. Rump needs additional finance to bring the product to market. The company is seeking to raise $40 million in debt finance through a bond issue. Rump would like to issue bonds with a face value of $1000, a maturity of 20 years and an 8 per cent annual coupon rate. Interest would be paid semi-annually. Rump is considering offering an 8 per cent coupon because it is not sure what rating its bonds would receive. Rodomontade has advised that similar bonds with an AA rating currently have a yield to maturity of 7.5 per cent and similar bonds with an A rating have a yield to maturity of 8.5 per cent. Required: (a) Calculate the price of the bonds, and the number of bonds Rump would need to issue, if the company was to receive an AA rating (b) Calculate the price of the bonds, and the number of bonds Rump would need to issue, if the company was to receive an A rating

Answer 1

Rump Industries
Bond Valuation
Par Value per Bond	$                    1,000
Semi Annual Coupon amount @8% pa=	$                         40
Maturity period in years =	20
No of Coupons payment in bond's life	40
YTM rates required for the Ratings

Type of Rating	AA rating	A Rating
Required YTM	7.50%	8.50%
Semi Annual YTM =	3.75%	4.25%
PV Factor for 40 periods at the semi annual YTM rate=1/(1+r)^n	0.2293	0.1892
PVIF Facto for 40 periods at the semi annual YTM rate=[1-(1+r)^-n]/r	20.5510	19.0773

Valuation of Bonds from PV of the cash flows Receivable in each case

	AA rating	A Rating
Particulars	Cash flow	PV/PVIF Factor	PV of Cash flows	Cash flow	PV/PVIF Factor	PV of Cash flows
Coupon Payment per period(Receivable for 40 peridos)	$                         40	$                     20.55	$          822.04	$                  40	19.0773	$          763.09
Maturity Amount Receivable	$              1,000.00	0.2293	$          229.30	$       1,000.00	0.1892	$          189.20
Total PV of Cash flows			$      1,051.34			$          952.29

	AA rating	A Rating
The Required bond Price	$              1,051.34	$                  952.29