Annie Hegg has been considering investing in the bonds of Atilier Industries. The bonds were issued 5
Question:
Annie Hegg has been considering investing in the bonds of Atilier Industries. The bonds were issued 5 years ago at their $1,000 par value and have exactly 25 years remaining until they mature. They have an 8% coupon interest rate, are convertible into 50 shares of common stock, and can be called any time at $1,080. The bond is rated Aa by Moody’s. Atilier Industries, a manufacturer of sporting goods, recently acquired a small athletic-wear company which was in financial distress. As a result of the acquisition, Moody’s and other rating agencies are considering a rating change for Atilier bonds. Recent economic data suggest that expected inflation, currently at 5% annually, is likely to increase to a 6% annual rate.
Annie remains interested in the Atilier bond but is concerned about inflation, a potential rating change, and maturity risk. To get a feel for the potential impact of these factors on the bond value, she decided to apply the valuation techniques she learned in her finance course.
To Do:
- For each of the following required returns, calculate the bond’s value, assuming annual interest. Indicate whether the bond will sell at a discount, at a premium, or at par value.
- Required return is 6%.
- Required return is 8%.
- Required return is 10%.
- Repeat the calculations in part c
- b, assuming that interest is paid semiannually and that the semiannual required returns are one-half of those shown. Compare and discuss differences between the bond values for each required return calculated here and in part b under the annual versus semiannual payment assumptions.
- If Annie strongly believes that expected inflation will rise by 1% during the next few months, what is the most she should pay for the bond, assuming annual interest?
- If the Atilier bonds are downrated by Moody’s from Aa to A, and if such a rating change will result in an increase in the required return from 8% to 8.75%, what impact will this have on the bond value, assuming annual interest?
- After evaluating all of the issues raised above, what recommendation would you give Annie with regard to her proposed investment in the Atilier Industries bonds?
Fundamentals of Financial Management
ISBN: 978-1337395250
15th edition
Authors: Eugene F. Brigham, Joel F. Houston