Case 8-3 Joan Holtz

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Joan Holtz (D)*
1. 2010 late-night talk show indicated the existence of an unclaimed municipal bond issued in 1883 by a town in Missouri. The bond was $100 with an interest rate on 10%. At a compound interest, what would be the bonds value in 2010.

2. (a) Joan read that a company issued eight-year, zero-coupon bonds at a price of 327 per 1,000 par value. The question asked, was the yield on these bonds 15 percent, as Joan had calculated. Yes!

(b) Assuming that bond discount amortization is tax deductible by the issuing corporation that has a .40 percent income tax rate, using a straight-line amortization of original discount is permissible. What is the effective or “true” after –tax interest rate to the issuer?

* Corporate Bonds- have no tax-free provisions on Zero Coupon Bonds. * Zero coupon bonds are sold at a deep discount and pay no annual interest. The full face value is paid at maturity. However, the IRS computes the implied annual interest and you are liable for that amount even though you do not actually receive it until the bond matures.

c) Instead of issuing these zero-coupon bonds, the company issued 15 percent coupon bonds with issue proceed of $1000.00 per bond (i.e., par value), what would the issuer’s effective after-tax interest rate have been on these alternative bonds? The same 40% rate, regular bonds are taxed the same as zero coupons. The only difference is that the holder of a zero-coupon bond does not receive cash payment until maturity. In any case, every year the issuer will send a statement telling you how much interest accrued to the bond that year.

In the case, the bond is amortized semiannually, accruing interest and taxes each year.

3. A- The company uses an investment banker as an intermediary to issue shares on the open market because bonds can only be issued to the public through the intermediary of an investment banker, insurance company or other financial institution. B- The...
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