Gillis Manufacturing Company has in its capital structure $20 million of 13.5 percent sinking-fund

QUESTION

Gillis Manufacturing Company has in its capital structure $20 million of 13.5 percent sinking-fund debentures. The sinking-fund call price is $1,000 per bond, and sinking-fund payments of $1 million in face amount of bonds are required annually. At present, the yield to maturity on the debentures in the market is 12.21 percent. To satisfy the sinking fund payment, should the company deliver cash to the trustee or bonds? What if the yield to maturity were 14.60 percent?
Answer A If the yield to maturity is 12.21 percent, the bonds will sell at a sizeable premium. As a result, the company should deliver $1 million in cash to the trustee Answer B If the yield is 14.60 percent, the bonds will sell at a discount from their

face value. Here the company should buy bonds in the market and deliver them to the trustee, as the outlay involved to purchase 1,000 bonds will be less than $1 million.

ANSWER:

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