Question

no rate of return provided

A city is sening a Dona to finance building a new convention center. The bond will be for $100 million, which is the cost of construction of the convention center, at 4.5% annual interest (it is a municipal bond so bond buyers do not pay federal or state income tax on the earnings). The interest payments are to be annual, and the bond matures (principal must be paid back) in 10 years. The city expects that it will average receipt of $11 million in fees from the convention center each year, and will receive $5 million every year in additional hotel tax revenue from people coming to town for events at the center. The asset securing the bond is the convention center. a. How much does the bond pay the investors every year? (this is divided up amongst all the bond buyers) b. What is the total cost of the bond to the city over the 10 years? c. How much money does the city expect to make off the convention center over the 10 years including the costs of paying all the costs of the bond? d. If the city does not pay back the bond at the end of the 10 years, who owns the convention center?

Answer 1

a. How much does the bond pay the investors every year?

The bond will pay investors annually the interest amount.

Interest Amount = Principal Outstanding * Coupon Rate

In the above question

Principal Outstanding = $100 million

Coupon Rate = 4.5%

Interest Amount = $100 million * 4.5% = $4.5 million

Therefore, the bond will pay the investors the interest amount which is $4.5 million every year.

b. Total Cost of the bond to the city?

The cost of the bond to the city will be the annual interest payment for 10 years plus the principal repayment at the end of the 10th year.

Annual Interest Payment = $4.5 million

Time = 10 years

Principal Repayment = $100 million

Total Cost to the City = (Annual Interest Payment * Time) + Principal Repayment = ($4.5 million * 10 years) + $100 million = $145 million

Therefore, the total cost of the bond to the investor would be $145 million over the course of 10 years.

(one could consider the principal repayment as a part of the cost if that is the case the principal repayment in the 10th year would be $100 million and the total cost would become Principal Repayment + Total Interest Payment over the course of 10 years which is $100 million + $45 million = $145 million. But, the principal repayment is not considered as a cost, cause it is basically a repayment of the loan.)

c. Profit from the convention centre

Revenue from the convention per year = Revenue from Receipts + Addition tax revenue from hotels

Revenue from Receipts per year = $11 million

Addition Hotel Tax Receipts per year = $5 million

Total Revenue per Year = $11 million + $5 million = $16 million

Total Revenue for 10 years = Total Revenue per Year * time = $16 million * 10 = $160 million

Therefore, the total revenue from the convention centre during a 10 year period is $160 million

The total cost of convention centre in 10 year period (calculated in above part) $145 million

The net benefit of the city in 10 years = Total Revenue over 10 years - Total cost over 10 years = $160 million - $145 million = $15 million

The money that the city expect to make off in 10 years = $15 million

d. If the city defaults on the loan repayment

If the city is unable to repay the principal amount at the end of the 10th year, the bondholders will own the convention centre. This is because the convention centre was given as the security to the bondholders.

Hope i was able to help you :)