Engineering Economy

Capital Financing
 Engineering Economy
Capital Financing

Capital Financing with Bonds

Classification of Bonds
1. Registered bonds
2. Coupon bonds
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Capital Financing

Methods of Bond Retirement

1. The corporation may issue another set of bonds equal to the amount of bonds due for
redemption.
2. The corporation may set up a sinking fund into which periodic deposits of equal amount are
made. The accumulated value in the sinking fund is equal to the amount needed to redeem
the bonds at the time they are due.

𝐴 = 𝑝𝑒𝑟𝑖𝑜𝑑𝑖𝑐 𝑑𝑒𝑝𝑜𝑠𝑖𝑡 𝑡𝑜 𝑡ℎ𝑒 𝑠𝑖𝑛𝑘𝑖𝑛𝑔 𝑓𝑢𝑛𝑑

𝐹 = 𝑎𝑐𝑐𝑢𝑚𝑢𝑙𝑎𝑡𝑒𝑑 𝑎𝑚𝑜𝑢𝑛𝑡 𝑜𝑟 𝑡ℎ𝑒 𝑡ℎ𝑒 𝑎𝑚𝑜𝑢𝑛𝑡 𝑛𝑒𝑒𝑑𝑒𝑑 𝑡𝑜 𝑟𝑒𝑑𝑒𝑒𝑚 𝑡ℎ𝑒 𝑏𝑜𝑛𝑑
𝑖 = 𝑟𝑎𝑡𝑒 𝑜𝑓 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑖𝑛 𝑡𝑒ℎ 𝑠𝑖𝑛𝑘𝑖𝑛𝑔 𝑓𝑢𝑛𝑑
𝑟 = 𝑏𝑜𝑛𝑑 𝑟𝑎𝑡𝑒 𝑝𝑒𝑟 𝑝𝑒𝑟𝑖𝑜𝑑
𝐼 = 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑜𝑛 𝑡ℎ𝑒 𝑏𝑜𝑛𝑑𝑠 𝑝𝑒𝑟 𝑝𝑒𝑟𝑖𝑜𝑑
𝐴 + 𝐼 = 𝑡𝑜𝑡𝑎𝑙 𝑝𝑒𝑟𝑖𝑜𝑑𝑖𝑐 𝑒𝑥𝑝𝑒𝑛𝑠𝑒
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Bond Value
The value of a bond is the present worth of all future amounts that are expected to be received
through ownership of the bond.

𝐹 = 𝑓𝑎𝑐𝑒 𝑣𝑎𝑙𝑢𝑒 𝑜𝑟 𝑝𝑎𝑟 𝑣𝑎𝑙𝑢𝑒

𝐹𝑟 = 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑏𝑜𝑛𝑑 𝑎𝑡 𝑖𝑡𝑠 𝑑𝑎𝑡𝑒 𝑜𝑓 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒
𝐶 = 𝑟𝑒𝑑𝑒𝑚𝑝𝑡𝑖𝑜𝑛 𝑜𝑟 𝑑𝑖𝑠𝑝𝑜𝑠𝑎𝑙 𝑝𝑟𝑖𝑐𝑒
𝑟 = 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑟𝑎𝑡𝑒 𝑜𝑟 𝑏𝑜𝑛𝑑 𝑟𝑎𝑡𝑒 𝑝𝑒𝑟 𝑝𝑒𝑟𝑖𝑜𝑑
𝑛 = 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑝𝑒𝑟𝑖𝑜𝑑𝑠 𝑝𝑒𝑟 𝑟𝑒𝑑𝑒𝑚𝑝𝑡𝑖𝑜𝑛
𝑖 = 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝑟𝑎𝑡𝑒 𝑜𝑟 𝑦𝑖𝑒𝑙𝑑 𝑝𝑒𝑟 𝑝𝑒𝑟𝑖𝑜𝑑
𝑉𝑛 = 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑡ℎ𝑒 𝑏𝑜𝑛𝑑 𝑛 𝑝𝑒𝑟𝑖𝑜𝑑𝑠 𝑏𝑒𝑓𝑜𝑟𝑒 𝑟𝑒𝑑𝑒𝑚𝑝𝑡𝑖𝑜𝑛
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𝑃 𝑃
𝑉𝑛 = 𝐹𝑟 , 𝑖%, 𝑛 + 𝐶 , 𝑖%, 𝑛
𝐴 𝐹
1 − 1 + 𝑖 −𝑛
𝑉𝑛 = 𝐹𝑟 +𝐶 1+𝑖 𝑛
𝑖
𝐹𝑖
𝐴𝐶𝐵 = 𝐴𝑛𝑛𝑢𝑎𝑙 𝐶𝑜𝑠𝑡 𝑜𝑓 𝐵𝑜𝑛𝑑 = 𝐹𝑟 +
1+𝑖 𝑛−1
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Illustrative Examples:

1. A bond with a par value of P1,000 and with a bond rate of 9% payable annually is to be redeemed at
P1,050 at the end of 6 years from now. If it is sold now, what should be the selling price to yield 8%?
Solution:
Par Value of the Bond (F): P1, 000+
Dividend rate of Bond (r): 9%
Redemption Price (C): P1050
Number of Periods (n): 6 years
Yield (i): 8%
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𝐶 1 − (1 + 𝑖)−𝑛
𝑉𝑛 = + 𝐹𝑟
(1 + 𝑖)𝑛 𝑖
𝑃1050 1 − (1 + 0.08)−6
𝑉𝑛 = + 𝑃1000(0.09)
(1 + 0.08)6 0.08
𝑽𝒏 = 𝑷𝟏, 𝟎𝟕𝟕. 𝟕𝟒
Engineering Economy
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2. A bond with a par value of P1,000 and with a bond rate of 10% payable annually is sold now for
P1,080. If the yield is to be 12%, how much should the redemption price be at the end of 8 years?
Solution: Value of the Bond (Vn) P1, 080
Par Value of the Bond (F): P1, 000
Dividend rate of Bond (r): 10%
Number of Periods (n): 8 years
Yield (i): 12%

𝐶 1 − (1 + 𝑖)−𝑛
𝑉𝑛 = + 𝐹𝑟
(1 + 𝑖)𝑛 𝑖
𝐶 1 − (1 + 0.12)−8
𝑃1080 = + 𝑃1000(0.10)
(1 + 0.12)8 0.12
𝑪 = 𝑷𝟏, 𝟒𝟒𝟒. 𝟎𝟕
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3. You purchase a bond at P5,100. The bond pays P200 per year. It is redeemable for P5050 at the
end of 10 years. What is the net rate of interest on your investment?
Solution: Value of the Bond (Vn) P5,100
Annual Dividend (Fr): P200
Number of Periods (n): 10 years
Redemption Price (C): P5, 050

𝐶 1 − (1 + 𝑖)−𝑛
𝑉𝑛 = + 𝐹𝑟
(1 + 𝑖)𝑛 𝑖
5050 1 − (1 + 𝑖)−10
𝑃5100 = + 𝑃200
(1 + 𝑖)10 𝑖
𝒊 = 𝟑. 𝟖𝟒%
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4. A company issued 50 bonds of P1,000 face value each, redeemable at par at the end of 15 years to
accumulate the funds required for redemption. The firm established a sinking fund consisting of
annual deposits, the interest rate of the fund being 4%. What was the principal in the fund at the end
of 12th year?
Solution: Par Value of the Bond (F): P50, 000
Number of Periods (n): 15 years
Yield (i): 4%

𝐹𝑖
𝐴𝑛𝑛𝑢𝑎𝑙 𝑆𝑖𝑛𝑘𝑖𝑛𝑔 𝐹𝑢𝑛𝑑 𝐴 =
(1 + 𝑖)𝑛 − 1
𝑃50, 000(0.04)
𝐴𝑛𝑛𝑢𝑎𝑙 𝑆𝑖𝑛𝑘𝑖𝑛𝑔 𝐹𝑢𝑛𝑑 𝐴 =
(1 + 0.04)15 − 1
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𝐴𝑛𝑛𝑢𝑎𝑙 𝑆𝑖𝑛𝑘𝑖𝑛𝑔 𝐹𝑢𝑛𝑑 𝐴 = 𝑃2, 497.06

(1 + 𝑖)𝑛 − 1
𝐹=𝐴
𝑖
(1 + 0.04)12 − 1
𝐹 = 𝑃2, 497.06
0.04
𝑭 = 𝑷𝟑𝟕, 𝟓𝟐𝟎. 𝟑𝟒
Engineering Economy
Capital Financing
Engineering Economy
Capital Financing
Engineering Economy
Capital Financing
Engineering Economy
Capital Financing
Engineering Economy
Capital Financing
Engineering Economy
Capital Financing