a bond that has a $1,000 par value (face value) and a contract or coupon interest rate of 10.1%. The bonds have a current market value of $1,125 and will mature in 10 years. The firm's marginal tax is 34%.
To determine the answer to your question, we need to calculate the annual interest payment and the yield to maturity (YTM) of the bond.
1. Annual Interest Payment:
The annual coupon interest payment is calculated by multiplying the par value of the bond ($1,000) by the coupon interest rate (10.1%) expressed as a decimal.
Annual Interest Payment = Par Value × Coupon Interest Rate
Annual Interest Payment = $1,000 × 0.101
Annual Interest Payment = $101
Therefore, the bond pays an annual coupon interest of $101.
2. Yield to Maturity (YTM):
The yield to maturity represents the total return expected from the bond, including the annual coupon interest payments along with any capital gains or losses upon maturity. To calculate the YTM, we need to find the discount rate that equates the current market value ($1,125) to the present value of the bond's future cash flows.
To calculate the YTM, we can use a financial calculator or an Excel spreadsheet using the following inputs:
N = Number of Years to Maturity = 10
PV = Present Value or Market Value = -$1,125 (negative sign represents an outflow)
PMT = Annual Cash Flow = $101
FV = Future Value or Maturity Value = $1,000
Using these inputs, we can calculate the YTM, which represents the rate of return on the bond.
3. Tax on Bond Interest:
The tax on bond interest is calculated by multiplying the annual interest payment ($101) by the marginal tax rate (34%) expressed as a decimal.
Tax on Bond Interest = Annual Interest Payment × Marginal Tax Rate
Tax on Bond Interest = $101 × 0.34
Tax on Bond Interest = $34.34
Therefore, the firm's tax liability on the bond interest is $34.34 per year.
Please note that the value of the bond provided assumes it is a premium bond since its market value is higher than the par value.