John Tye was hired as the new corporate finance analyst at I-EII Enterprises and

Question

John Tye was hired as the new corporate finance analyst at I-EII Enterprises and received his first assignment. John is to take the $25 million in cash received from a recent divestiture, to use part of these proceeds to retire an outstanding $10 million bond issue, and to use the remainder to repurchase common stock. However, the bond issue cannot be retired for another two years. If John can place the funds necessary to retire this $10 million debt into an account earning a 6 percent annual return compounded monthly, how much of the $25 million remains to repurchase stock?

Explanation / Answer

In this case we first need to determine the present value of debt obligation (retirement of bond) after 2 years. The present value of a lump sum amount can be calculatd with the use of following formula:

Present Value = Amount/(1+Rate)^n where n = Period

Since, the compounding is monthly rate would be taken as Rate/12 and Period would be taken as Years*2

Amount Remaining for Repurchase = Total Amount - Present Value of Debt Obligation

_______________

Solution:

Present Value of Debt Obligation = 10,000,000/(1+6%/12)^(2*12) = $8,871,856.7 or $8,871,857

The amount of $8,871,857 when invested today at a rate of 6% (compounded monthly) for a period of 2 years will generate $10,000,000, thereby, leaving more amount with the company for stock repurchase as shown below:

Amount Remaining for Repurchase = 25,000,000 - 8,871,857 = $16,128,143 (answer)

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