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You sell a bond for $11M. This bond has a 20-year maturity, a face value of $10M, a beta of 0.10, and promises an annual coupon payment of 5 percent of the face value. Assume a risk-free rate of 4 percent and a market risk premium of 6 percent. Markets are not necessarily efficient in this question, meaning that the bond could potentially be mispriced.

a) What is the NPV of financing due to potential bond mispricing? This is calculated as the money received for selling the bond minus the present value of the bond cash payments (coupons and face value).

b) Assume a tax rate of 35 percent. What is the value of the tax shield generated by this bond? What is the NPV of financing from issuing this bond? (in this case, this will equal the NPV of bond mispricing plus the NPV of the tax shield)

c) What is the value of the tax shield generated by an identical bond that is issued in perpetuity?

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Financial Management, Finance

  • Category:- Financial Management
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