ACCA Applied Skills · Financial Management · The valuation of debt and other financial assets
Zentra Co has in issue irredeemable bonds with a coupon rate of 6% on a nominal value of $100. Interest is paid annually and the next payment is due in one year. Investors in similar bonds currently require a pre-tax return of 8%. What is the market value of each $100 bond, ignoring tax?
The bond is worth $75.00. Irredeemable debt is a perpetuity, so its value equals the annual interest of $6 divided by the investors' required return of 8%. The coupon rate is not the discount rate, so the bond trades below its $100 nominal value.
- A$75.00Correct
- B$80.00
- C$92.59
- D$133.33
Explanation
Irredeemable debt value = annual interest / required return = $6 / 0.08 = $75.00. Using the 6% coupon as the discount rate would give $100, and $6 x 1.08 / 0.08 type errors do not apply. The $133.33 option inverts the ratio (8/6 x $100), and $80 wrongly uses 8% of nominal as interest.
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