1) Suppose Unique Motors Company sold an issue of bonds on January 1, 2001. The bonds were sold for $960 per unit (i.e., they were issued at 96 percent of par), had a 12 percent coupon rate payable semi-annually, and matures in 20 years, i.e., on December 31, 2020.
a) If you bought the bond on the issue date at the issue price and expected to hold it until it matures on December 31, 2020, what would be your average annual rate of return on the investment?
b) Two years after the bonds were issued, the going rate of interest on similar bonds fell to 8 percent. At what price would the bonds sell?
c) Six years after the initial offering, the going interest rate on similar bonds rose to 14 percent. At what price would the bonds sell?
d) Eight years after the issue, the bonds were selling for $925. What is the bond's yield to maturity at this point? What is the current yield? What is the capital gains yield?
2) Excel Corp. has recently witnessed a period of depressed earnings performance. As a result, cash dividend payments have been suspended. Investors do not anticipate a resumption of dividends until two years from today, when a yearly dividend of $0.25 will be paid. That yearly dividend is expected to be increased to $0.85 in the following year and $1.40 in the year after that. Beyond the time when the $1.40 dividend is paid, investors expect Excel's dividends to grow at an annual rate of 5 percent into perpetuity. All dividends are assumed to be paid at the end of each year. If you require an 18 percent rate of return on Excel's stock, what is the value of one share of this stock to you today?
3) Huntington Industries is developing the relevant cash flows associated with the proposed replacement of an existing machine tool with a new, technologically advanced one. Given the following costs related to the proposed project, explain whether each would be treated as a sunk cost or an opportunity cost in developing the relevant cash flows associated with the proposed replacement decision. Note: it is not sufficient to simply identify each item as sunk cost or opportunity cost. You must explain why the item is a sunk cost or an opportunity cost.
a) Huntington would be able to use the same tooling, which had a book value of $40,000, on the new machine tool as it had used on the old one.
b) Huntington would be able to use its existing computer system to develop programs for operating the new machine tool. The old machine tool did not require these programs. Although the firm's computer has excess capacity available, the capacity could be leased to another firm for an annual fee of $17,000.
c) Huntington would have to obtain additional floor space to accommodate the larger new machine tool. The space that would be used is currently being leased to another company for $10,000 per year.
d) Huntington would use a small storage facility to store the increased output of the new machine tool. The storage facility was built by Huntington three years earlier at a cost of $120,000. Because of its unique configuration and location, it is currently of no use to either Huntington or any other firm.
e) Huntington would retain an existing overhead crane, which it had planned to sell for its $180,000 market value. Although the crane was not needed with the old machine tool, it would be used to position raw materials on the new machine tool.
4) Looner Industries is considering investing in a new manufacturing plant. The plant requires an item of equipment that costs $200,000. In addition, Looner will spend $10,000 on shipping costs and $30,000 on installation charges. The equipment will be housed in a building currently owned by the company. The building was bought at a cost of $75,000 five years ago, but it could be sold now for $125,000. Similar buildings in the area are leasing for $5,000 per month.
You estimate that if the new plant is constructed, the company will increase its inventories by $25,000, while accounts payable also will rise by $5,000. New sales from the plant are estimated to be 120,000 units per year, at a price of $3.50 per unit. Variable costs are expected to total 60% of sales, while fixed costs are estimated at $20,000 per year. The plant has an estimated economic life of 4 years, after which time it will be scrapped for $25,000 (excluding the building). Depreciation will be calculated using the 3-year MACRS rates of 33%, 45%, 15%, and 7% for the first through the fourth year, respectively. Looner Industries' marginal tax rate is 40%, and its cost of capital is 10%. Should the plant be built?
5) The Macrohard Corporation projects an increase in sales from $18 million to $25 million, but it needs an additional $500,000 of current assets to support this expansion. Macrohard purchases under terms of 2/10, net 45 and currently pays on the 10th day, taking discounts. The CFO is considering using trade credit to finance the additional working capital required. Alternatively, Macrohard can finance its expansion with a one-year loan from its bank. The bank has quoted the following alternative loan terms:
a) 10 percent rate on a simple interest loan, with monthly interest payments.
b) 9 percent annual rate on a discount interest basis with no compensating balance.
c) 8 percent annual rate on a discount interest basis, with a 10 percent compensating balance.
d) 7 percent add-on interest, with monthly payments.
Based strictly on cost considerations only, what should Macrohard do to finance its expansion?