Question 1: KIC, Inc., plans to issue $6 million of perpetual bonds.The face value of each bond is $1,000.
The annual coupon on the bonds is 9 percent. Market interest rates on one-year bonds are 8 percent.With equal probability, the long-term market interest rate will be either 12 percent or 6 percent next year. Assume investors are risk-neutral.
a. If the KIC bonds are noncallable, what is the price of the bonds?
b. If the bonds are callable one year from today at $1,250, will their price be greater than or less than the price you computed in (a)? Why?
Question 2. Leases R Us, Inc Problem-Calculating Annual Payments Leases R Us, Inc. (LRU) has been contracted by Robotics of Beverly Hills (RBH) to provide lease financing for a machine that would assist in automating a large part of their current assembly line. Annual lease payments will start at the beginning of each year. The purchase price of this machine is $250,000, and it will be leased by RBH for a period of 5 years. LRU will utilize straight line depreciation of $50,000 per year with a zero book salvage value. However, salvage value is estimated to actually be $50,000 at the end of 5 years. LRU is required to earn a 12%, after-tax rate of return on the lease. LRU uses a marginal tax rate of 35%. Calculate the annual lease payments. (Remember, these payments are to be considered at the beginning of each year-annuity due.)