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BUSINESS VALUATIONS
20 Kevin Dutton is an investor who specialises in buying corporate debt at discounted values
and aims to make gains either by selling bonds at a higher value later or by receiving
redemption payments. Kevin is currently evaluating the following investments:
Last year Kevin bought $1m nominal value of unquoted 5% bonds in Company A at a price
of $500,000. The bonds are to be redeemed at par in 5 years’ time but Company A is
showing signs of financial distress. To value the bonds Kevin has estimated that a return of
30% is appropriate here to compensate for the risks of non?payment.
Company B, a forestry company, is looking to raise $5 million through the issue of 6 year
deep discounted zero coupon bonds. The issue price has been set at a 40% discount. Kevin
may invest but is looking for a return of 10% per annum to do so.
Kevin also owns fixed rate bonds in Company C. These bonds are traded on major bond
markets. Kevin is thinking of selling them now as he believes that interest rates are going to
increase shortly resulting in a drop in the bond price.
All three companies mentioned pay tax at 25%.(b) Calculate the gross redemption yield on the deep discounted bonds. Give your
answer as a percentage to 1 dp.
%I don’t know how to calculate this
The bonds are zero coupon and so pay no interest.
They are issued at a discount of 40%, so for an outflow at time 0 of $60, the investor will receive an inflow of $100 in 6 years time.
The gross redemption yield is, as usual, the IRR of these flows.
How did u get 60$ at time 0 and how the inflow is 100…plz explain full calculation coz I didn’t understand
Have you not watched my free lectures on this? The lectures are a complete free course for Paper FM (it is not called F9 now) and cover everything needed to be able to pass the exam well.
Bonds are issued in units with a nominal/par value of $100.
If they issued at a discount of 40% then investors will pay 100 – (40% x 100) = $60.
They will be redeemed at par in 6 years time, so in 6 years time the investors will be repaid $100.
As we have said above:
The gross redemption yield on the deep discounted bonds can be calculated as the internal rate of return (IRR) of the cash flows associated with the bond.
Have you not watched my free lectures on this? The lectures are a complete free course for Paper FM (it is not called F9 now) and cover everything needed to be able to pass the exam well.
MV Debt (x) value PV = 60
Period 1 – 6 Int (1-t) this is zero
Redemption 100
Find were the NPV of cashflows = 0
As there is no interest on the bonds
The IRR of these two figures is the return.
So F = P (1+r) ^ n
So 100 = (60) * (1+r) ^ 6
100 / 60 ^ (1/6) = 1+r
1.089 = 1+r
r = 8.9%or alternatively look at PV table as no annuity interest
so look along the 6 year row which PV factor is 1:0.6 or 100=60
10% look at 6 years
100 * 0.564 = 56.40 that has to equal 60 which it doesn’t
at 8% look at 6 years
100 * 0.630= 63 which is over 60
at 9’% look at 6 years
100 * 0.596 = 59.6 which is nearly 60
so it’s nearly 9%
can u plz tell me how to find this ques whole third part
this is the third part ques
Calculate the minimum discount required so the deep discounted bonds give a return over 10%. Give your answer to the nearest whole percent.
ans is fourty four percent idk how to do itTo calc the disc req’d to give 10% return:
You calculate the PV of future c f/low at 10%
As the bonds pay no interest, the only c/flow to consider is the redemption which it says $100 in 6 yrsSo you take $100 * (pv of 6 yrs @ 10%) 0.564 = $56.40
This shows the discount to be $43.60 (diff $100 – $56.40) which is 44%
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