(Q4 IN TYPE B) BCE WAS RECENTLY BEEN BOUGHT OUT BY A U.S. PRIVATE...

14. (Q4 in Type B) BCE was recently been bought out by a U.S. private equity firm who levered the company and now BCE is having cash flow problems. Its existing bonds have the following terms: 6% coupon, $1000 face value and they mature in 10 years. Bonds of equivalent risk yield 12%. BCE is asking the bondholders to swap their existing bonds into 5 year zero-coupon bonds with a face value of $1000. Assuming BCE will not be in default during the next 10 years, should existing bondholders accept the deal? A) No, because the existing bonds are worth more. B) Yes, because, the zero coupon bonds are worth more. C) Yes, because the zero coupon bonds have a shorter 5 year maturity. D) No, because zero coupon bonds do not pay interest. Solution: A Current Price of existing bonds: PMT = $30, n = 10 x 2 = 20, FV = $1000, I = 12/2 = 6, COMP PV -> PV = $655.90 Current value of Zero-coupon bonds: PV = $1000/ (1.12)

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= $567.43 As long as BCE will not be in default of its bond payments, the bondholders should keep their existing bonds as they have a higher PV.