- 12 Marks
FM – L2 – Q15 – Business valuations
Question
Assume that bond investors in Ama Industries require a return of 9% per year on their investments.
Required:
(A) Estimate the market value of irredeemable 7.5% bonds that pay interest annually.
(B) Estimate the market value of bonds paying coupon interest of 6% per year annually, that are redeemable at par in four years’ time.
(C) Estimate the market value of bonds paying coupon interest of 10%, redeemable at par after three years, where interest is payable every six months.
(D) Estimate the market value of a convertible bond with a coupon of 5% and interest payable annually; these bonds are convertible after three years into equity shares at the rate of 20 shares for every GH₵100 nominal value of bonds. The expected share price in three years’ time is GH₵7.
Answer
(A). (7.5 / 9.0) × 100 = 83.33. (GH₵83.33 market value for each GH₵100 nominal value of bonds.)
(B).
| Year | Item | Cash flow | Discount factor at 9% | PV |
|---|---|---|---|---|
| 1-3 | Interest | 6 | 2.531 | 15.19 |
| 4 | Interest plus capital | 106 | 0.708 | 75.05 |
| 90.24 |
The market value of the bonds should be 90.24.
(C).
| Period | Item | Cash flow | Discount factor at 4.4% | PV |
|---|---|---|---|---|
| 1-7 | Interest | 5 | 5.914 | 29.57 |
| 8 | Interest plus capital | 105 | 1/(1.044)^8 | 74.40 |
| 103.97 |
The market value of the bonds should be 103.97.
(D).
| Year | Item | Cash flow | Discount factor at 9% | PV |
|---|---|---|---|---|
| 1-3 | Interest | 5 | 2.531 | 12.66 |
| 3 | Value of shares acquired | 140 | 0.708 | 99.12 |
| 111.78 |
The market value of the bonds should be 111.78.
- Tags: Bond valuation, Business valuations, Interest rate, Irredeemable bonds
- Level: Level 2
- Topic: Business valuations
- Uploader: Samuel Duah