Question

CHAPTER 7 INSTRUCTIONS: Answer each letter in the following problems. Show work when necessary. Problem 3 a) Determine the market price of a $750,000, five-year, 12% (pays interest semiannually) bond issue sold to yield an effective rate of 10%. b) Jill Morris is presently leasing a small business computer from Eller Office Equipment Company. The lease requires 10 annual payments of $6,000 at the beginning of each year and provides the lessor (Eller) with an 8% return on its investment. Assuming the computer has a ten-year life and will have no salvage value at the expiration of the lease, what was the original cost of the computer to Eller?

Answer 1

Requirement a:

Face Value of Bond = Maturity Value = $750,000

Coupon Rate = 12%

Semi-annual Interest Payment

= Face Value * Coupon Rate * 6/12

= $750,000 * 12% * 6/12

= $45,000

Life of Bond = 5 years

Number of Compounding periods = 5*2 = 10

Effective Rate of Interest = 10%

Semi-annual Effective Rate of Interest = 10*1/2 = 5%

Market Price of Bond

= Present Value of expected Future Cash Flows

= Present Value of Interest + Present Value of Maturity Value

= [Interest * PVAF(5%, 10)] + [Maturity Value * PVIF(5%, 10)]

= [$45,000 * 7.721735] + [$750,000 * 0.613913]

= $347,478 + $460,435

= $807,913

Market Price of Bond = $807,913

Requirement b:

Annual lease payment = $6,000

Return on Investment = 8%

Number of Annual Payments = 10

Original Cost of Computer

= Present Value of the future expected payments

= Present Value of lease payments

= $6,000 + ($6,000 * PVAF(8%, 9))

= $6,000 + ($6,000 * 6.246888)

= $6,000 + $37,481

= $43,481

Original Cost of Computer = $43,481