- This topic has 1 reply, 2 voices, and was last updated 7 years ago by
.
- Posts
Dear tutor,
I am struggling with a very simple question of CIMA F2 paper. It is regarding calculation IRR (Internal Rate of Return). The exact question is:
Knife plc also has some 7% coupon, $100 nominal value bonds in issue, which are redeemable at a 10% premium in 5 years. The current market value of the bonds is $98.
Required:
Calculate the yield to maturity for these bonds.I also have the solution which is like follows:
The yield to maturity for these redeemable bonds is found by taking the IRR of the current market value (98 at t0 ), the annual interest (7 per annum from t1 to t5 ), and the redemption amount (110 at t5 ), as follows:
Time $ DF 5% PV DF 10% PV
t0 (98) 1 (98) 1 (98)
t1 – t5 7 4.329 30.30 3.791 26.54
t5 110 0.784 86.24 0.621 68.31
––––– –––––
18.54 (3.15)
Hence IRR = 5% + [(10% – 5%) × 18.54/(18.54 + 3.15)] = 9.27%Would you please explain this? I am not getting how the amounts of DF and PV columns come. What does DF mean?
Thanks
NaziaDF is short for discount factor. So the 5 year discount factor at 10% from the tables given in the exam is 0.621. So the present value (PV) of the redemption amount is 110 x 0.621 = 68.31
For the 7 per year, this is a 5 year annuity and so the annuity discount factor at 10% is 3.791, and the present value is 7 x 3.791 = 26.54.
Have you watched our free lectures on this?
- The topic ‘Internal Rate of Return’ is closed to new replies.