Vanda Development has just sold a $ 100 million, 10 year, 12 per cent bond issue. A sinking fund will retire the issue over its life. Sinking fund payments are of equal amounts and will be paid semi-annually and the proceeds will be used to retire the bonds as the payments are made. Bonds can be called at par for sinking fund purposes, or the funds paid into the sinking fund can be used to buy bonds in the open market.
a) How large must each semi-annual sinking fund payment be?
b) What will happen to the company’s debt service requirements per year for this issue over time?
c) Now suppose the Vanda Development set up its sinking fund so that equal annual payments are made at the end of each year into the sinking fund trust held by a bank. The proceeds are used to buy government bonds that pay 9 per cent interest. The payments plus accumulated interest must total 100 million at the end of 10 years, and the proceeds will be used to retire the bonds at that time. How large must the annual sinking fund payment be now?
d) What would have to happen to interest rates to cause the company to buy bonds on the open market rather than call them under the original sinking fund plan?
e) What are the advantages of bonds?