Evaluate Business Case, answering USING EXCEL
(make sure to show caculations)
Oncor Power and Water (your company’s electric and water supplier) has just issued a new tax free municipal bond for purchase. There are $50,000,000 of bonds available for purchase. You can purchase $1,000,000 of these bonds. They will mature in 10 years and pay 5.5% annual interest, tax free return. At the end of 10 years all investors will receive the interest payment that is due for that year, plus the principal that they had initially invested.
The brokerage fee for purchasing the bond on your firm’s behalf is 1% of the purchase price, payable at the time of purchase. The brokerage fee will be taken out of other company funds so the total bond purchase will still equal $1,000,000 worth of bonds, plus $10,000 in transaction fees. Due to the fact that there is a water shortage in Texas these bonds have been rated AA-. The bonds are selling at 2 points above par value. Therefore you have a decision to make; you can purchase $1,000,000 worth of bonds for $1,020,000 or $980,392 worth of bonds for $1,000,000. In each case the brokerage fee will still be $10,000. You have been given approval to spend the additional $ above the purchase price for this opportunity.
In addition to the interest payments, as a bond holder, your Firm will receive a $20,000 annual credit to offset your water and electric bills from Oncor Power and Water, for as long as you hold the bond. This credit will be taxed by the Federal Government at a 21% tax rate. (Your company currently has an annual water and power bill of $25,000.)
Historically, Oncor has always paid back their bond obligations therefore you and your manager feels that a rate of return = 5.5% would be an appropriate risk adjusted rate of return that the firm should accept. Both of you feel that you can convince the CFO of accepting a lower return due to the low risk nature of this investment.