Chapter 5.

Problem 1

(a) Coupon rate P90 interest

= P1,000 par

= 9%

(b) Current P90 interest

rate/yield = P820 market price

= 10.98%
(c) Annual Interest Principal Payment – Price of the Bond
Approximate = +
Yield Payment
.6 (Price of the Bond)Number of Years
+ .4 (Principal to Maturity
Payment)
to Maturity
P1,000 − P820
P90 + 5
=
.6 (P820) + .4 (P1,000)

P180
P90 + 5
=
P492 + P400

P90 + P36
=
P892
P126
= P892

= 14.13%

Problem 2
Bond A Bond B
(a)
Current P80 interest Current P85 interest
rate/yield = P800 market price rate/yield = P900 market price

= 10% = 9.44%

(b) The bond that the investor should select is Bond A because it has a higher current yield.
Approximate Annual Interest Principal Payment – Price of the Bond
(c) = Payment + Number of Years to Maturity
Yield
to Maturity .6 (Price of the Bond) + .4 (Principal Payment)

P1,000 − P900
P85 + 2
=
.6 (P900) + .4 (P1,000)

P100
P85 + 2
=
P540 + P400

P85 + P50
=
P940
P135
= P940

= 14. 36%

(d) Yes. Bond B now has the higher yield to maturity. This is because the P100 discount will be recovered over only two years.
With Bond A, there is a P200 discount, but a 10-year recovery period.
Chapter 25 Sources of Long-term Financing

Problem 3

(a) PV of P1,000 for: n = 20, i = 11%, PVIF = .124

P1,000
x .124
P 124

(b) PV of P1,000 for: n = 20, i = 9%, PVIF = .178

P1,000
x .178
P 178

(c) PV of P1,000 for: n = 20, i = 13%, PVIF = .087

P1,000
x .087
P 87

Problem 4

Note:
Life of the asset is 15 years, not 5 years.

Since one of the five criterias that is the length of the lease contract is 10 years and the economic life of the asset is 15 years, the
arrangement constitutes a major part of the asset’s life, for compulsory treatment as a capital lease is indicated; the transaction
must be treated as a capital lease.

Problem 5

(a) Determine 10-year annuity that will yield 12%:

A = PVA/PVIFA (i = 12%, n = 10)

P900,000
= 5.650

= P159,292

(b) The 10% deduction reduces the net cost to P810,000.

Original cost P900,000
10% 90,000
Net cost P810,000

Annual lease P810,000

payment = 5.650

= P143,362.80

Problem 6

Since the dividends grow at 9.8 percent, the next three annual dividends will be:

D1 = P1.68 (1.098) D2 = P1.84 (1.098) D3 = P2.03(1.098)

= P1.84 = P2.03 = P2.22

Discounting these cash flows results in a value of:

P1.84 P2.03 P2.22 + P72

Po = 1 + 0.135 + (1 + 0.135) 2 + (1 + 0.135) 3

= P1.63 + P1.58 + P50.76

= P53.96

At the current P54 per share price, the equity share does not appear undervalued. It appears fairly valued.

25-2
Problem 7

It is not initially clear whether this will be good or bad news for the equity share price. A rise in the growth rate increases the
equity share’s value. But a higher required return lowers the value. The two changes somewhat offset one another. Since the
current P70 equity share price is fair, investors require a return of 11.5 percent (1.75 ÷ 70 + 0.09) before the announcement.
After the announcement, investors will require a 12.7 percent return (0.115 + 0.012) and expect a 10 percent growth rate.
Therefore, the new equity share price should be P64.81 per share, a decline of P5.19 (− 7.4 percent).

Po = P1.75
0.127 − 0.10
= P64.81

This was bad news for the equity share price.

Problem 8

Founder’s family votes = Shared owned x 10

= 51,325 (10)
= 513,250

Class B votes = Total votes – Founder’s family shares

= 1,200,000 – 51,325
= 1,148,675

Founder’s family votes 513,250

Class B votes = 1,148,675

= 44.68%

Problem 9

(a) Treasury bonds = 9% (1 − .35)

= 9% (.65)
= 5.85%

(b) Corporate bonds = 12% (1 − .35)

= 12% (.65)
= 7.80%

(c) Preferred share = Dividends reserved by a corporation from another corporation is not taxable in the Philippines. The
yield is therefore 10% also.
The preferred share should be selected because it provides the highest after-tax return.
Problem 10

(a) Preferred share P100,000

Dividend yield 8%
Dividend P8,000
After-tax income P8,000

(b) Loan P100,000

Interest expense 10%
Interest P 10,000
x (1 – T) 66%
After-tax borrowing cost P 6,600

(c) Yes, the after-tax income exceeds the after-tax borrowing cost. Of course, other factors may be considered as well.

Problem 11

Dividend P8,000
After-tax income P8,000

Interest P 10,000
x (1 – T) 85%

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Chapter 25 Sources of Long-term Financing
After-tax borrowing cost P 8,500

No, the after-tax income is now less than the after-tax borrowing.

Problem 12

The annual interest payment of P140 is computed by multiplying the coupon rate of 14 percent by the P1,000 par value of the
bond.

Problem 13

The bond will sell at a premium because the required rate of return is less than the bond’s coupon rate. Thus, investors are
willing to pay more for this bond because it pays more interest than newly issued bonds with similar characteristics.

Problem 14

(a) Bond Y should have the greater price sensitivity to a change in the required rate of return because of its longer maturity. That
is, the present value of future cash flows is more affected by changes in discount rates than less distant cash flows.

(b) The intrinsic value of each bond is as follows:

For Bond X, when I = P80, kd = 9 percent, and n = 5

Po = (P80) (3.890) + (P1,000) (0.650)

= P311.20 + P650
= P961.20

For Bond Y, when I = P80, kd = 9 percent, and n = 15

Po = (P80) (8.060) + (P1,000) (0.275)

= P644.80 + P275
= P919.80

(c) Each bond sold for its par value of P1,000 before the change in the required rate of return. Bond Y would decline in value by
P80.20 (P1,000 – P919.80) compared to a P38.80 (P1,000 – P961.20) decline for Bond X.

Problem 15

The required rate of return is:

Dp
Po = kp

Solve for kp:

kp Dp
= Po

P6.75
= P75.25

= 8.97%
Problem 16

Substituting Dp = P2.60 and ks = 0.13, the current value is:

P2.60
Po = 0.13

= P20.00

Problem 17

Using the Gordon constant growth dividend model, the current value of a share of Zeth Industries is:

(a) For D1 = P1.32 (P1.20 x 1.10), ks = 0.15, and g = 0.10

P1.32
Po =
P26.40– 0.10
0.15
= 25-4
(b) For D1 = P1.30 (P1.20 x 1.085), ks = 0.15, and g = 0.085
P1.30
Po = 0.15 – 0.085

= P20.00

(c) For D1 = P1.35 (P1.20 x 1.125), ks = 0.15, and g = 0.125

P1.35
Po = 0.15 – 0.125

= P54.00

25-5