Final answer:
When Ranger Inc. considers issuing 20-year bonds, they must evaluate factors such as current interest rates, credit rating, investor demand, and overall capital strategy. Using a bond example, if interest rates rise, the price of existing bonds falls, and the present value of future payments is adjusted accordingly to match the current market yields. The example shows how to calculate the price you would be willing to pay for a $10,000 6% bond when the market rate is 9% close to maturity.
Step-by-step explanation:
Ranger Inc.'s decision to issue new 20-year bonds involves several financial considerations. These considerations include the current interest rate environment, the company's credit rating which affects the interest rate it will have to pay, the potential demand from investors, and how the bond issuance fits into their overall capital structure strategy. It's also important to consider the timing of the market, potential covenants required by bondholders, and tax implications.
Turning to our example with a water company bond, if you are thinking of buying a $10,000 ten-year bond at a 6% interest rate from the water company one year before maturity, but now the interest rates are at 9%, you would expect to pay less than $10,000 for the bond due to the inverse relationship between bond prices and interest rates.
Assuming the bond pays interest annually, it would have one payment of $600 (6% of $10,000) left. If the market interest rate is 9%, a new $10,000 bond would pay $900 a year. Since the water company bond pays less interest than the expected 9%, it would be discounted to make it an equivalent investment.
In order to calculate what you would be willing to pay for this bond, you would need to calculate the present value of the remaining $600 payment at the new market interest rate of 9%.
The calculation would be the future payment divided by (1 + market interest rate), which in this case is $600 / (1 + 0.09) = $550.46. This would be the price you'd be willing to pay for the bond to match the market rate of return.