LP8.2 Financial Assignment: Bond and Loan Problems This assignment will assess t

Question

LP8.2 Financial Assignment: Bond and Loan Problems This assignment will assess the competency 7. Analyze the impact on organizational financial position of accounts receivable, inventory, and cash management, along with other aspects of working capital management.

Directions: In a word document work out the financial problems below.

To earn full credit you must show all your calculations.

1. You wish to retire a $10,000,000 bond that can be called in 5 years for 110 percent of par value, or $11,000,000. You also need to make year-end interest payments of $700,000 per year in each of the next five years. If you can invest money at 8 percent, how much money must you set aside today to meet these obligations?

Hint: ($11,000,000 x 0.681) + ($700,000 x 3.993) = ?

2. Your firm is considering the following three alternative bank loans for $1,000,000:

a) 10 percent loan paid at year end with no compensating balance Hint: 10% x $1,000,000 / $1,000,000 = ?

b) 9 percent loan paid at year end with a 20 percent compensating balance

Hint: 9% x $1,000,000 / $1,000,000 – (20% x $1,000,000) = ?

c) 6 percent loan that is discounted with a 20 percent compensating balance requirement

Hint: 6% x $1,000,000 / $1,000,000 – {20% x ($1,000,000 – (6% x $1,000,000))] = ?

Assume that you would normally not carry any bank balance that would meet the 20 percent compensating balance requirement. What is the rate of annual interest on each loan?

Explanation / Answer

1. Money that needs to be set aside must be sum of present value of interest payments over 5 years and value of investments in 5th year. The discount rate os 8%. Therefore, money required

($11,000,000 x 0.681) + ($700,000 x 3.993) = $10,286,100

2. The rate of interest on each loan is calculated below

a) 10% x $1,000,000 / $1,000,000 = 10%

b) 9% x 1,000,000/[1,000,000 - 0.20 x 1,000,000)]

= 11.25%

c) 6% x 1,000,000/[1,000,000 - 0.20 x (1,000,000 – (6% x $1,000,000))] = 60,000/812,000= 7.39%

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