(Bond valuation) Eagle Ventures has a bond issue outstanding with an annual coupon rate of 7 percent and 4 years remaining until maturity. The par value of the bond is $1,000. (a) Determine the current value of the bond if present market conditions justify a 14 percent required rate of return. Assume the bond pays interest annually
Solutions for valuation bonds
To determine the current value of the bond, we can use the concept of present value. Present value is the current worth of future cash flows, discounted at a specified rate of return.
In this case, the future cash flows are the annual coupon payments and the face value of the bond at maturity. The rate of return is the required rate of return or yield.
Step 1: Calculate the annual coupon payment
The annual coupon payment can be determined by multiplying the coupon rate by the face value of the bond:
Annual coupon payment = Coupon rate * Face value of the bond
= 0.07 * $1,000
= $70
Step 2: Determine the number of periods until maturity
The bond has 4 years remaining until maturity. Since the bond pays interest annually, we will use this number as the number of periods.
Step 3: Calculate the present value of the coupon payments
To calculate the present value of the coupon payments, we will discount each cash flow back to its present value and then sum them up.
Present value of coupon payments = (Annual coupon payment / (1 + Required rate of return))^1
+ (Annual coupon payment / (1 + Required rate of return))^2
+ (Annual coupon payment / (1 + Required rate of return))^3
+ (Annual coupon payment / (1 + Required rate of return))^4
Step 4: Calculate the present value of the face value at maturity
The face value of the bond at maturity is $1,000. To calculate its present value, we will discount it back to its present value.
Present value of face value at maturity = Face value of the bond / (1 + Required rate of return)^4
Step 5: Calculate the current value of the bond
The current value of the bond is the sum of the present values of the coupon payments and the present value of the face value at maturity.
Current value of the bond = Present value of coupon payments + Present value of face value at maturity
Using the provided information, with a coupon rate of 7 percent, a required rate of return of 14 percent, and 4 years remaining until maturity, you can use the above steps to calculate the current value of the bond.