A firm has $4 million in bonds that mature in 4 years @ a fixed rate of 7.5% paid annually. The market price is $98. The marginal tax rate is 35%. With the bond-yield plus method, what is the cost of equity assuming an add-on of 4%?

When I input the following:

[PV] - 98

[PMT] 7.5

[FV] 100

[N] = 4

I get a rate of 8.11% , the correct figure, but when I use

[PV] 98

[PMT] 7.5

[FV] - 100

[N] = 4

I get the incorrect rate of 7.09%. I recall from quant methods that you have to input either [PV] or [FV] with a - sign, but I don’t believe it mattered which one you made negative. Why am I getting different results here? Thanks!

Whenever I teach Level I Quant, I tell my candidates to decide on one viewpoint in TVM calculations and stick with it. You can take the viewpoint of the:

Lender/bondholder

Borrower/bond issuer

It doesn’t matter which viewpoint you take – in the sense that you can get the correct answer either way – but if you always take the same viewpoint, you won’t make silly mistakes.

If you take the lender/borrower viewpoint, then,

PV is negative: you pay for the bond today, a cash outflow

PMT is positive: you receive the coupon payments, cash inflows

FV is positive: you receive the par value at maturity, a cash inflow

If you take the viewpoint of the borrower/bond issuer, then,

PV is positive: you receive payment for the bond today, a cash inflow

PMT is negative: you make the coupon payments, cash outflows

FV is negative: you repay the par value at maturity, a cash outflow