The firm has grown so fast that its management is considering the issuance of a five-year...

The firm has grown so fast that its management is considering the issuance of a five-year interest-only note. The notes would have a principal amount of $1,000 and pay 12% interest each year, with the principal amount due at the end of Year 5. The firm’s investment banker has agreed to help the firm place the notes and has estimated that they can be sold form $800 each under today’s market conditions.

1. What is the promised yield to maturity based on the terms suggested by the investment banker?

2. The firm’s management looked with dismay at the yield to maturity estimated above. The investment banker explained that for a small firm such as International Tile, the bond rating would probably be in the middle of the speculative grades, which requires a much higher yield to attract investors. The banker even suggested that the firm recalculate the expected yield to maturity on the debt under the following assumption: The risk of default in Years 1 throught 5 is 5% per year, and the recovery rate in the event of default is only 50%. What is the expected yield to maturity under these conditions?

Expert Solution

E(cash flow)t=π ( 1 + C ) F+( 1 - π ) λ F

jeff jeffy answered 1 year ago

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