Questions:
1. Garland Corporation has a bond outstanding with a $90 annual interest payment, a market price of $820, and a maturity date in five years.
Find the following:
a.) The coupon rate.
b.) The current rate.
c.) The approximate yield to maturity.
2. An investor must choose between two bonds:
Bond A pays $80 annual interest and has a market value of $800. It has 10 years to maturity.
Bond B pays $85 annual interest and has a market value of $900. It has two years to maturity.
a.) Compute the current yield on both bonds.
b.) Which bond should he select based on your answer to part a?
c.) A drawback of current yield is that it does not consider the total life of the bond. For example, the approximate yield to maturity on Bond A is 11.36 percent. What is the approximate yield to maturity on Bond B?
d.) Has your answer changed between parts b and c of this question in terms of which bond to select?
3. Match the yield to maturity in column 2 with the security provisions (or lack thereof) in column 1. Higher returns tend to go with greater risk.
Security Provisions Yield to Maturity
4. Cox Media Corporation pays an 11 percent coupon rate on debentures that are due in 20 years. The current yield to maturity on bonds of similar risk is 8 percent. The bonds are currently callable at $1,060. The theoretical value of the bonds will be equal to the percent value of the expected cash flow from the bonds.
a.) Find the theoretical market value of the bonds using semiannual analysis.
b.) Do you think the bonds will sell for the price you arrived at in part a? Why?
5. The Deluxe Corporation has just signed a 120-month lease on an asset with a 15-year life. The minimum lease payments are $2,000 per month ($24,000 per year) and are to be discounted back to the present at a 7 percent annual discount rate. The estimated fair value of the property is $175,000.
Should the lease be recorded as a capital lease or an operating lease? Use criteria 3 and 4 on page 511 for a capital lease.
6. Howell Auto Parts is considering whether to borrow funds and purchase an asset or to lease the asset under an operating lease arrangement. If the company purchases the asset, the cost will be $10,000. It can borrow funds for four years at 12 percent interest. The firm will use the three-year MACRS depreciation category (with the associated four-year write-off). Assume a tax rate of 35 percent. The other alternative is to sign two operating leases, one with payments of $2,600 for the first two years, and the other with payments of $4,600 for the last two years. In your analysis, round all values to the nearest dollar.
a.) Compute the aftertax cost of the leases for the four years.
b.) Compute the annual payment for the loan (round to the nearest dollar).
c.) Compute the amortization schedule for the loan. (Disregard a small difference form a zero balance at the end of the loan-due to rounding.)
d.) Determine the depreciation schedule (see Table 12-9).
e.) Compute the aftertax cost of the borrow-purchase alternative.
f.) Compute the present value of the aftertax cost of the two alternatives. Use a discount rate of 8 percent.
Aftertax
g.) Which alternative should be selected, based on minimizing the present value of after costs?