Answer to Question #129709 in Financial Math for Yamkela Banjwa

Question

Company Y has a AAA credit rating from Standard and Poor’s. The company can obtain long-term loans from banks, from which it could borrow at the government bond yield rate plus a premium of 5%. The government bond yield is 10%. AAA rated bonds generally have a spread of 2% (200 points) in relation to government bonds. Which financing option should Company Y choose?

Answer 1

where are some n comparing financing options , here are some loan options to review:

1.interest rate 2. loan term 3. monthly payment 4. total amount

here, as other data is not available , we will compare borrowing rates.

(1) Goverment bond

cost of common equity = bond yield + risk premium

= 10 + 5

= 15%

(2) AAA rated bonds

spread rate = AAA rated bond yield - govt bond yield

2 = x - 10

x = 12 %

AAA rated bond interest is 12%

The company Y should choose financing through AAA rated bonds .