$9.($Omit$)$

Zero Coupon Bonds

Suppose your company needs to raise $$10$ million and you want to issue $20-$year bonds for this

purpose. Assume the required return on your bond issue will be $9$ percent, and you$$re evaluating

two issue alternatives: a $9$ percent annual coupon bond, and a zero coupon bond. Your

company$$s tax rate is $35$ percent.

a$.$ How many of the coupon bonds would you need to issue to raise the $$10$ million? How

many of the zeroes would you need to issue?

b$.$ In $20$ years, what will your company$$s repayment be if you issue the coupon bonds?

What if you issue the zeroes?

c$.$ Consider the firm$$s after tax cash flow for the first year under the two scenarios. Why

would you want to ever issue zero coupon bonds?