a) Find the value of 11% Irredeemable Bonds of the face value of Rs.5,000 each, if the required rate of return is 9%, 12%, and 20%.
b) Find the value of 8% Irredeemable preference shares of Rs.100 each, if the required rate of return is 10%, 12%, and 15%.
Answer (1)
To find the value of irredeemable bonds and preference shares, we use the formula for the valuation of perpetual securities, which is:
Value of Security = Required Rate of Return Annual Coupon/Cash Flow
Part a: 11% Irredeemable Bonds
The bonds have a face value of Rs. 5,000 with an annual coupon of 11%, which means the coupon payment (annual interest) is:
Annual Interest = 5000 × 0.11 = Rs. 550
Required Rate of Return at 9%
Value = 0.09 550 = Rs. 6,111.11
Required Rate of Return at 12%
Value = 0.12 550 = Rs. 4,583.33
Required Rate of Return at 20%
Value = 0.20 550 = Rs. 2,750.00
Part b: 8% Irredeemable Preference Shares
The preference shares have a face value of Rs. 100 with an annual dividend of 8%, which means the dividend payment is:
Annual Dividend = 100 × 0.08 = Rs. 8
Required Rate of Return at 10%
Value = 0.10 8 = Rs. 80
Required Rate of Return at 12%
Value = 0.12 8 = Rs. 66.67
Required Rate of Return at 15%
Value = 0.15 8 = Rs. 53.33
These calculations show how the value of bonds and preference shares changes based on the required rate of return, which reflects the yield demanded by investors. A higher required rate of return leads to a lower value of the security, indicating that the bonds or shares are less attractive at higher rates.
