1. On March 22, 2013 Tenkiller Torque Technology (TTT) was taken private in a leveraged buyout financed in part by a $5 billion issue of Pay-in-Kind (PIK) zero-coupon bonds. TTT's outstanding PIK bonds are not scheduled to make any interest payments during the next ten years, providing the new management with a time window for increasing the firm's operating cash flow before being required to cover the full interest burden on the debt issued to finance the leveraged buyout. After ten years, on March 22, 2023, the PIK bonds will automatically convert to a 25-year bond having a 5 percent coupon rate and a March 22, 2048 maturity. The first coupon payment for the PIK bonds is scheduled to be paid on September 22, 2023. The face value of each bond is $1000. Assuming that the market currently requires a yield to maturity of 5 percent for TTT's PIK bonds:
a. Calculate the market price for the bonds as of March 22, 2013.
b. assuming that the required yield to maturity for TTT's PIK bonds increases to 5.6 percent on March 22, 2014, evaluate the rate of return that could have been earned by an investor who purchased the PIK bonds on March 22, 2013 and sold the PIK bonds on March 22, 2014.
2. The city of Rio Linda is currently in a difficult budgetary position due to the failure of the city council to either raise property taxes or reduce expenditures. Bond market analysts agree that there is a 20 percent probability that the city will default on its outstanding debt during the next year, causing the bondholders to lose 100 percent of their original investment. The city's outstanding debt consists of a single bond issue having one year to maturity, a 4.5 percent coupon rate and a face value of $1000. The coupon payments on the bonds, which are exempt from State and Federal taxes, are paid annually (once per year) with the final coupon payment occurring at the end of the year. The annualized yield to maturity for risk- free US Government bonds having one year to maturity is 4.0 percent. The tax rate for investors who earn the same after-tax return from tax-exempt municipal bonds and US government bonds is 25 percent. Assuming that investors determine the prices of municipal bonds by discounting their expected payoffs using the discount rate for risk-free municipal bonds, determine the promised yield to maturity for Rio Linda's outstanding issue of 4.5 percent coupon bonds.
3. Mag-Lev Wind Turbines (MLWT) expects to have earnings for the fiscal year ending (in six years) on March 22, 2019 of $5.00 per share. At this time, MLWT is expected to pay its first- ever dividend of $3.00 per share. Beginning with the 2019 fiscal year end, and continuing in perpetuity, MLWT is expected to reinvest a constant fraction of earnings in the business at a constant return on equity ROE of 15 percent. Assuming that on March 22, 2018 (one year prior to the first dividend payment) the stock of MLWT is expected to sell at a forward- looking price to earnings ratio of 12.5, Calculate:
a. the long-run earnings growth rate for MLWT
b. the current (date 0) share price for MLWT
4. Valley Proteins is evaluating the purchase of a new centrifuge to be used in settling out the fine particles from the liquid feed ingredients produced by the firm. The old centrifuge was purchased from the Bird Machine Company, but must now be replaced due to a new EPA mandate limiting energy consumption for centrifuges. A new energy efficient Bird centrifuge would cost $400,000 and have a useful life of 6 years. However, the firm is also evaluating the purchase of a Harburg-Freudenberger centrifuge, which would cost $575,000 and have a useful life of 8 years. Although the Bird centrifuge is less expensive, the yearly cost of maintenance at the end of each year would be $38,000. The Harburg-Freudenberger centrifuge can be operated for a full two-year period without downtime for maintenance, but requires an extensive overhaul costing $50,000 at the end of each two-year operating cycle. The Internal Revenue Service permits manufacturing equipment used in agricultural production (including centrifuges) to be depreciated to a zero salvage value over a 5-year life. Assuming that Valley Proteins has a tax rate of 30 percent and that their opportunity cost of capital (required return) is 10 percent, determine whether the firm should purchase the centrifuge from Harburg-Freudenberger or the Bird Machine Co. centrifuge.
5. Scissortail Real Estate Partners is evaluating a proposal to purchase two idle manufacturing facilities located near Blackwell, Oklahoma. The combined cost of purchasing these properties would be $13 million. Each facility has 3000 amps of 480 volt 3 phase electrical power and close proximity to the air cargo facilities at Cherokee Strip regional airport. However, an immediate expenditure of $6 million dollars will be required to install cleanrooms in each facility and bring the electrical wiring into compliance with local building codes. The total time required to upgrade and resell both properties is expected to be four years. The CFO for Scissortail projects that at the end of two years the first facility can be sold for $20 million. The second facility, whose configuration is somewhat less desirable, will take four years to sell, with an expected selling price of $13 million. Revisions to the tax code designed to help stimulate the economy exempt any profits from renovating idle manufacturing capacity from all State and Federal taxes. Assuming that the date 2 cash flows from the project can be reinvested at an annual rate of 4.2 percent:
a. Evaluate the internal rate of return for the project.
b. Evaluate the reinvested rate of return for the project.
c. concisely Illustrate why the reinvested rate of return is greater than or less than the internal rate of return for the project (no points will be awarded for a simple comparison of the internal rate of return and the reinvested rate of return).
6. The CEO for the Bynum Manufacturing, a producer of building materials located in Durant, Oklahoma, is evaluating a proposal to begin producing asphalt shingles at the firm's idle manufacturing facility on the North side of Denison, Texas. Although the vacant facility has no conceivable alternative use, it is carried on Bynum's books at its historical cost of $3,000,000. The equipment required for the production of asphalt shingles, including Surfacing Sections, an Accumulator, a Granule Mixing System with proportional valve control, and Shingle Cutters will cost $40 million and can be expected to have a useful life of 9 years. The Internal Revenue Service allows machinery used in producing construction materials to be depreciated to a zero salvage value over 5 years using straight-line depreciation. Sales are expected to be $36,000,000 per year during each of the next 9 years. The variable costs of production are expected to be 66.6667 percent of sales. Although the project will not require an investment in accounts receivable, the chief financial officer estimates that the firm will need to maintain an inventory of finished shingles. The industry standard for inventory turnover on the manufacturing side of the construction industry is 24 times per year. The firm has an opportunity cost of capital of 10 percent and a corporate tax rate of 35 percent. Assuming that at the end of 9 years, soon to be enacted EPA regulations will make further investment in the production of asphalt shingles unprofitable, determine whether the firm should undertake the investment in shingle production.