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28 July, 13:32

Choate International plans to issue $15 million in 10-year bonds. They believe they can afford to pay $1,150,000 in interest to bondholders each year.

Which annual interest rate should they use for their bonds? The current market interest rate is 7.75% for similar bonds.

A) 7.75% B) 7.65% C) 8.1% D) 6.5%

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  1. 28 July, 17:07
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    Correct option is (B)

    Explanation:

    Given:

    Bond issue amount = $15,000,000

    Market interest rate = 7.75%

    Investors cannot pay interest more than $1,150,000

    Choate cannot choose 6.5%, the bond will become less attractive to investors as it indicates that the bond is selling at discount.

    If 7.75% interest is given that is the market interest, then interest amount would be $1,162,500 (15,000,000 * 0.0775)

    Choate cannot afford to pay more than $1,150,000, so it cannot offer bonds at 7.75% or 8.1%.

    The only option left is 7.65%. Interest amount would be $1,147,500 (15,000,000 * 0.0765) which is less than what the company can afford. Also, it is just marginally lesser than market interest rate of 7.75%, so bonds would still be attractive.

    Choate should select 7.65%.
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