CHAPTER 7 BONDS AND THEIR VALUATION

Taxes on zero coupon bond

7A-[i]. Today is January 1, 2003 and you just purchased a 7-year, zero coupon bond with a face value of $1,000 and a yield to maturity of 6 percent. Your tax rate is 30 percent. How much in taxes will you have to pay on the bond the first year that you hold it?

a. $ 11.97

b. $211.49

c. $ 12.69

d. $ 39.90

e. $199.52

Taxes on zero coupon bond

7A-[ii]. A zero coupon bond with a face value of $1,000 matures in 15 years. The bond has a yield to maturity of 7 percent. If an investor buys the bond at the beginning of the year, how much money in taxes will the investor have to pay on the zero coupon bond the first year. Assume that the investor has a 25 percent marginal tax rate.

a. $5.25

b. $5.44

c. $5.99

d. $6.25

e. $6.34

Accrued value and interest expense

7A-[iii]. Vogril Company issued 20-year, zero coupon bonds with an expected yield to maturity of 9 percent. The bonds have a par value of $1,000 and were sold for $178.43 each. What is the expected interest expense on these bonds for Year 8?

a. $29.35

b. $32.00

c. $90.00

d. $26.12

e. $25.79

Tough:

Zeros and expectations theory

7A-[iv]. A 2-year, zero coupon Treasury bond with a maturity value of $1,000 has a price of $873.4387. A 1-year, zero coupon Treasury bond with a maturity value of $1,000 has a price of $938.9671. If the pure expectations theory is correct, for what price should 1-year, zero coupon Treasury bonds sell one year from now?

a. $798.89

b. $824.66

c. $852.28

d. $930.23

e. $989.11

Zeros and expectations theory

7A-[v]. A 4-year, zero coupon Treasury bond sells at a price of $762.8952. A 3-year, zero coupon Treasury bond sells at a price of $827.8491. Assuming the expectations theory is correct, what does the market believe the price of 1-year, zero coupon bonds will be in three years?

a. $921.66

b. $934.58

c. $938.97

d. $945.26

e. $950.47

Zero coupon bond

7A-[vi]. Assume that the State of Florida sold tax-exempt, zero coupon bonds with a $1,000 maturity value 5 years ago. The bonds had a 25-year maturity when they were issued, and the interest rate built into the issue was a nominal 8 percent, compounded semiannually. The bonds are now callable at a premium of 4 percent over the accrued value. What effective annual rate of return would an investor who bought the bonds when they were issued and who still owns them earn if they were called today?

a. 4.41%

b. 6.73%

c. 8.25%

d. 9.01%

e. 9.52%

Zero coupon bond

7A-[vii]. Assume that the City of Tampa sold an issue of $1,000 maturity value, tax exempt (muni), zero coupon bonds 5 years ago. The bonds had a 25-year maturity when they were issued, and the interest rate built into the issue was a nominal 10 percent, but with semiannual compounding. The bonds are now callable at a premium of 10 percent over the accrued value. What effective annual rate of return would an investor who bought the bonds when they were issued and who still owns them earn if they were called today?

a. 12.01%

b. 10.25%

c. 10.00%

d. 11.63%

e. 12.37%

Taxes on zero coupon bond

7A-[viii]. Schiffauer Electronics plans to issue 10-year, zero coupon bonds with a par value of $1,000 and a yield to maturity of 9.5 percent. The company has a tax rate of 30 percent. How much extra in taxes would the company pay (or save) the second year (at t = 2) if they go ahead and issue the bonds?

a. Save $12.59

b. Save $13.79

c. Save $41.97

d. No savings

e. Pay $13.79

Multiple Part:

(The information below applies to the next two problems.)

Gargoyle Unlimited is planning to issue a zero coupon bond to fund a project that will yield its first positive cash flow in three years. That cash flow will be sufficient to pay off the entire debt issue. The bond’s par value will be $1,000, it will mature in 3 years, and it will sell in the market for $727.25. The firm’s marginal tax rate is 40 percent.

Zero coupon interest tax shield

7A-[ix]. What is the nominal dollar value of the interest tax savings to the firm in the third year of the issue?

a. $ 32.58

b. $ 40.29

c. $100.72

d. $ 60.43

e. $109.10

After-tax cost of debt

7A-[x]. What is the expected after-tax cost of this debt issue?

a. 11.20%

b. 4.48%

c. 6.72%

d. 6.10%

e. 4.00%

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