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Chapter 6: Question 7E (page 302)
What would you pay for a \(100,000 debenture bond that matures in 15 years and pays \)5,000 a year in interest if you wanted to earn a yield of: (a) 4%? (b) 5%? (c) 6%?
The bond price at 4% is $111,118, at 5% is $100,000, and at 6% is $90,288.
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Sosa Excavating Inc. is purchasing a bulldozer. The equipment has a price of \(100,000. The manufacturer has offered a payment plan that would allow Sosa to make 10 equal annual payments of \)16,274.53, with the first payment due one year after the purchase. Instructions (a) How much total interest will Sosa pay on this payment plan? (b) Sosa could borrow $100,000 from its bank to finance the purchase at an annual rate of 9%. Should Sosa borrow from the bank or use the manufacturer’s payment plan to pay for the equipment?
James Kirk is a financial executive with McDowell Enterprises. Although James Kirk has not had any formal training in finance or accounting, he has a “good sense” for numbers and has helped the company grow from a very small company (\(500,000 sales) to a large operation (\)45 million in sales). With the business growing steadily, however, the company needs to make a number of difficult financial decisions in which James Kirk feels a little “over his head.” He therefore has decided to hire a new employee with “numbers” expertise to help him. As a basis for determining whom to employ, he has decided to ask each prospective employee to prepare answers to questions relating to the following situations he has encountered recently. Here are the questions.
(a) In 2016, McDowell Enterprises negotiated and closed a long-term lease contract for newly constructed truck terminals and freight storage facilities. The buildings were constructed on land owned by the company. On January 1, 2017, McDowell took possession of the leased property. The 20-year lease is effective for the period January 1, 2017, through December 31, 2036. Advance rental payments of \(800,000 are payable to the lessor (owner of facilities) on January 1 of each of the first 10 years of the lease term. Advance payments of \)400,000 are due on January 1 for each of the last 10 years of the lease term. McDowell has an option to purchase all the leased facilities for \(1 on December 31, 2036. At the time the lease was negotiated, the fair value of the truck terminals and freight storage facilities was approximately \)7,200,000. If the company had borrowed the money to purchase the facilities, it would have had to pay 10% interest. Should the company have purchased rather than leased the facilities?
(b) Last year the company exchanged a piece of land for a non-interest-bearing note. The note is to be paid at the rate of \(15,000 per year for 9 years, beginning one year from the date of disposal of the land. An appropriate rate of interest for the note was 11%. At the time the land was originally purchased, it cost \)90,000. What is the fair value of the note?
(c) The company has always followed the policy to take any cash discounts on goods purchased. Recently, the company purchased a large amount of raw materials at a price of $800,000 with terms 1/10, n/30 on which it took the discount. McDowell has recently estimated its cost of funds at 10%. Should McDowell continue this policy of always taking the cash discount?
Consolidated Natural Gas Company (CNG), with corporate headquarters in Pittsburgh, Pennsylvania, is one of the largest producers, transporters, distributors, and marketers of natural gas in North America.
Periodically, the company experiences a decrease in the value of its gas- and oil-producing properties, and a special charge to income was recorded in order to reduce the carrying value of those assets.
Assume the following information. In 2016, CNG estimated the cash inflows from its oil- and gas-producing properties to be \(375,000 per year. During 2017, the write-downs described above caused the estimate to be decreased to \)275,000 per year. Production costs (cash outflows) associated with all these properties were estimated to be \(125,000 per year in 2016, but this amount was revised to \)155,000 per year in 2017.
Instructions (Assume that all cash flows occur at the end of the year.)
(a) Calculate the present value of net cash flows for 2016–2018 (three years), using the 2016 estimates and a 10% discount factor.
(b) Calculate the present value of net cash flows for 2017–2019 (three years), using the 2017 estimates and a 10% discount factor.
(c) Compare the results using the two estimates. Is information on future cash flows from oil- and gas-producing properties useful, considering that the estimates must be revised each year? Explain.
Andrew Bogut just received a signing bonus of \(1,000,000. His plan is to invest this payment in a fund that will earn 8%, compounded annually. Instructions (a) If Bogut plans to establish the AB Foundation once the fund grows to \)1,999,000, how many years until he can establish the foundation? (b) Instead of investing the entire \(1,000,000, Bogut invests \)300,000 today and plans to make 9 equal annual investments into the fund beginning one year from today. What amount should the payments be if Bogut plans to establish the $1,999,000 foundation at the end of 9 years?
Recently, Glenda Estes was interested in purchasing a Honda Acura. The salesperson indicated that the price of the car was either \(27,600 cash or \)6,900 at the end of each of 5 years. Compute the effective-interest rate to the nearest percent that Glenda would pay if she chooses to make the five annual payments.
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