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Minicase 1: Interest Rates, Bond Yields, and Duration
$5.00You have been hired to analyze the debt securities of your organization. The firm has outstanding loans and bonds. A quick review of the balance sheet shows the following:
Liability
Amount ($)Nominal
Interest
(coupon)
RateYears to
MaturitySelected Liabilities of the firm Simple Loans 800 5% 1 Fixed-Payment Loans 5,000 12% 19 Long-term Bonds #1 500,000 10% 4 Long-term Bonds #2 1,080,000 10% 10 Liabilities Total 1,585,800 Market Price for Bond #1 930.50 Market Price for Bond #2 859.50 Face Value of Each Bond 1,000.00 Selected Current Assets of the firm Marketable Securities: Treasury Bills 100,000 Note: Treasury Bills have a $10,000 face value, which matures in one year. Each Treasury Bill has a cost of $9,580.00
How much interest would the firm pay each year on the simple-interest loan?
How much would you write a cheque for to pay off the loan in one year?
What is the monthly payment needed to pay off the fixed-payment loans?
What is the current yield for each bond if the current price is:
$930.50 for Bond #1?
$859.50 for Bond #2?
What is the expected yield to maturity for each bond?
Bond #1 selling for $930.50?
Bond #2 selling for $859.50
What is the rate of capital gain if both bonds sell for $900.00 in one year?
Bond #1 selling for $930.50 today?
Bond #2 selling for $859.50 today?
If the Yield to Maturity expected by investors changes to 11%:
What will be the market price of Bond #1?
What will be the market price for Bond #2?
What will be the dollar change in price for Bond #1?
What will be the dollar change in price for Bond #2?
What will be the percent change in price for Bond #1?
What will be the percent change in price for Bond #2?
Since the change in expected yield to maturity is the same, why is the amount of change different between the bonds?
If investors holding our 4-year bonds (Bond #1) receive interest income annually for four years, plus the face value of the bonds at maturity,
What will be the total interest earned on the bond over the next four years?
What will be the face value received at maturity?
Given the following projected income stream for Bond #1:
Projected Reinvestment Rates Year Coupon
Interest ($)Face
Value ($)10% 5% 1 100 2 100 10.00 5.00 3 100 21.00 10.25 4 100 1000 33.10 15.76 Total Income 400 1000 64.10 31.01 What is the total cash available over the next four years to the bond holder earning
10%
15%
What is the average annual rate of return for the bond holder earning
10%
15%
Why does the reinvestment rate affect the annual rate of return for the same bond?
If the expected rate of return on our bonds is 10%, what is the duration of Bond #1?
What is the yield to maturity on the Treasury Bills (a discount bond)?
What is the real rate of interest if the nominal rate is 10% and the inflation rate is 3%?
MINICASE: Old Alfred Road
$0.00Old Alfred Road, who is well-known to drivers on the MaineTurnpike, has reached his seventieth birthday and is ready toretire. Mr. Road has no formal training in finance but has savedhis money and invested carefully.
Mr Road owns his home-the mortgage is paid off-and dose not want tomove.He is a widower,and he wants to bequeath the house and anyremaining assets to his daughter.He has accumulated savings of $180,000, conservatively invested.The investments are yielding 9 percent interest. Mr. Road also has$12,000 in a savings account at 5 percent interest. He wants tokeep the savings account intact for unexpected expenses oremergencies.
Mr. Road’s basic living expenses now average about $1,500 permonth, and he plans to spend $500 per month on travel and hobbies.To maintain this planned standard of living, he will have to relyon his investment portfolio. The interest from the portfolio is$16,200 per year (9 percent of $180,000), or $1,350 per month.
Mr. Road will also receive $750 per month in social securitypayments for the rest of his life. These payments are indexed forinflation. That is, they will be automatically increased inproportion to changes in the consumer price index.
Mr. Road’s main concern is with inflation. The inflation rate hasbeen below 3 percent recently, but a 3 percent rate is unusuallylow by historical standards. His social security payments willincrease with inflation, but the interest on his investmentportfolio will not.
What advice do you have for Mr. Road? Can he safely spend all theinterest from his investment portfolio? How much could he withdrawat year-end from that portfolio if he wants to keep its real valueintact?
Suppose Mr. Road will live for 20 more years and is willing to useup all of his investment portfolio over that period. He also wantshis monthly spending to increase along with inflation over thatperiod. In other words, he wants his monthly spending to stay thesame in real terms. How much can he afford to spend per month?
Assume that the investment portfolio continues to yield a 9 percentrate of return and that the inflation rate will be 4 percent.Florida Car Wash Capital Budget Analysis Question
$1.00
Text: Florida Car Wash is considering a new project whose capital budget analysis and sensitivity analysis data are shown below.
Please explain what this data tells management and should they consider approving the investment?
Tensaw Chemical plans Investment Decision Analysis
$1.00Text: Tensaw Chemical plans to invest $200,000 and has identified the following three investments. Investment A requires an initial investment of $ 120,000 and has an annual rate of return of 18%. Investment B an initial investment of $80,000 and has an annual rate of return of 22%. Investment C requires an initial investment of $20,000 and has an annual rate of return of 35%. Any unused funds require deposit in a bank account with an annual percentage yield of 6%. Tensaw Chemical may invest in each of the investments only once. All of the investments have a one-year life.
Using rate of return analysis determine which alternative Tensaw Chemical should choose.
Capital Investment Analysis
$1.00
Text: Computation of payback period, accounting rate of return, and net present value Concorde Company is planning to add a new product to its line. To manufacture this product, the company needs to buy a new machine at a $100,000 cost with an expected five-year life and a $ 25,000 salvage value. All sales are for cash and all costs are out of pocket, except for depreciation on the new machine. Additional information includes the following. Required 1. Compute straight-line depreciation for each year of this new machine’s life. (Round depreciation amounts to the nearest dollar.) 2. Determine expected net income and net cash flow for each year of this machine’s life. (Round answers to the nearest dollar.) 3. Compute this machines payback period, assuming that cash flows occur evenly throughout each year. (Round the payback period to two decimals.) 4. Compute this machine’s accounting rate of return, assuming that income is earned evenly throughout each year. (Round the percentage return to two decimals.) 5. Compute the net present value for this machine using a discount rate of 12% and assuming that cash flows occur at each year-end. (Hint: Salvage value is a cash inflow at the end of the asset’s life.)
Consumers became more future oriented and thus decided to save more
$1.00Question:
investment and real interest rate
After the recession, consumers became more future oriented and thus decided to save more. Use the saving-investment analysis to analyze the effects of this change on investment and real interest rate.
Cash flow: Which project or projects you should undertake based on PW analysis
$1.00
Text: Consider the following sets of independent investment projects with three – year investment life: Which project or projects you should undertake based on PW analysis? Assume MARR 15%.
Sunshine Food Company Case: Divisional Income Statements and Rate of Return on Investment Analysis
$1.00Sunshine Food Company is a diversified food company with three operating divisions organized as investment centers. Condensed data taken from the records of the three divisions for the year ended June 30, 2014, are as follows:
Cereal
DivisionSnack Cake
DivisionRetail
Bakeries
DivisionSales $ 5,520,000 $ 5,900,000 $5,330,000 Cost of goods sold 3,370,000 3,660,000 3,140,000 Operating expenses 1,156,400 942,000 804,200 Invested assets 6,900,000 5,900,000 4,100,000 The management of Sunshine Food Company is evaluating each division as a basis for planning a future expansion of operations.
Required:
1. Prepare condensed divisional income statements for the three divisions, assuming that there were no service department charges.
Brodigan Corporation: Net Present Value
$1.00
Text: Brodigan Corporation has provided the following information concerning a capital budgeting project: Investment required �n equipment Net annual operating cash inflow After-tax discount rate The expected life of the project and the equipment is 3 years and the equipment has zero salvage value. The company uses straight-line depreciation on all equipment and the depreciation expense on the equipment would be dollar150,000 per year. Assume cash flows occur at the end of the year except for the initial investments. The company takes income taxes into account in its capital budgeting. The net annual operating cash inflow is the difference between the incremental sales revenue and incremental cash operating expenses. Required: Determine the net present value of the project. Show your work!
