Subject: Corporate Finance

Individual Assignment

1. Vernox wishes to borrow $10000 for three years. A group of individuals

agrees to lend him this amount if he contracts to pay them $16000 at the end of the
three years. What is the implicit compound annual interest rate implied by this
contract (to the nearest whole percent)? (10 marks)
Time line:
0

PV=10.000_ _ _ _ _ _ _ _ _ _FV= 16.000

The Future value of initial $10000 for three years:
FV3= PV (1+i)3
The implicit compound annual interest rate implied by this contract:
(1+i)3= FV3/ PV =16.000/10.000=1.6
1+i=1.61/3
i= 1.61/3-1= 1,169-1=0,169=16,9%
2. Joe has inherited $25000 and wishes to purchase an annuity that will provide him
with a steady income over the next 12 years. He has heard that the local savings and loan
association is currently paying 6 percent compound interest on annual basis. If he were to
deposit his funds, what year-end equal-dollar amount (to the nearest dollar) would he be
able to withdraw annually such that he would have a zero balance after his last
withdrawal 12 years from now? (10 marks)
0

8 9 10 11 12 Year

i=6%
PVA n =25.000

FV=0

The present value of ordinary annuity that Joe has inherited:

1

Subject: Corporate Finance

Individual Assignment

1
(1+i)n

1 PVA n= PMT x
i

(1 + i)n 1
PVA n= PMT x

=
i(1 + i)n

The year-end equal-dollar amount that he be able to withdraw annually:

PMT= PVA n x i(1 + i)n = 25.000x 6% (1+6%)12
(1 + i)n 1

(1+6%)12-1

= $2982
3. Gonzalez Company has outstanding a 10% bond issue with a face value of
$1000 per bond and three years to maturity. Interest is payable annually. The bonds
are privately held by Suresafe Insurance Company. Suresafe wishes to sell the
bonds, and is negotiating with another party. It estimates that, in current market
conditions, the bond should provide a (nominal annual) return of 14 percent. (20
marks).
a. What price per bond should Suresafe be able to realize on the sale?
M=100
INT = 10% x 1000 = 100
n=3
0

1
100

100

100
1000

PV1
2

Subject: Corporate Finance

Individual Assignment

PV2
PV3
The price per bond should Suresafe be able to realize on the sale:

VB

=
=

INT

(1 + rd)n - 1

rd (1 + rd)n
100 x (1+14%) 3 -1
14% (1+14%) 3

+
+

M
(1 + rd)n
1000
(1+14%) 3

= $ 907, 1
b. What would be the price per bond if interest payment were made semiannually?
M=1000
INT = (10% x 1000)/2 = 50
n=3x2=6
i nom= 0.14
i per=14%/2=7%

50

50

50

50

50

50
1000

PV1
PV2
PV3
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Subject: Corporate Finance

Individual Assignment

PV4
PV5
PV6

VB

INT

(1 + rd)n - 1

rd (1 + rd)n

50 x (1+7%) 6 -1

M
(1 + rd)n

+ 1000

14% (1+14%) 6

(1+7%) 6

= $ 904,6
4. Red Brewery has $1000-par value bonds outstanding with the following
characteristics: currently selling at par; 5 years until final maturity; and a 9 percent
coupon rate (with interest paid semiannually). Interestingly, Blue Brewery has a
very similar bond issue outstanding. In fact, every bond feature is the same as Red
bonds, except that Blue bonds mature in exactly 15 years. Now assume that the
markets nominal annual required rate of return for both bond issues suddenly fell
from 9 percent to 8 percent. (20 marks)
a. Which brewerys bonds would show the greatest price change? Why?
When coupon rate = 9% . Coupon rate= r d , both bonds sell at its par value ($1000)
INT Red= INT Blue = M x i % = 1000* (9% / 2) = 1000 x 0.45 = 45
n= 5*2= 10

VB Red

=
=

INT

(1 + rd)n - 1

rd (1 + rd)n
45 x (1+0.45) 10 -1
4.5% (1+4.5%) 10
4

M
(1 + rd)n
+
1000
(1+4.5%) 10

Subject: Corporate Finance

Individual Assignment

= $ 1000
VB Blue

(1 + rd)n - 1

INT

rd (1 + rd)n
45 x (1+4.5 %) 30 -1
0.45 (1+4.5%) 30

M
(1 + rd)n
+
1000
(1+4.5%) 30

= 733+267
= $ 1000
However, when the markets nominal annual required rate of return for both bond
issues suddenly fell from 9 percent to 8 percent r d = 8%/2 = 4%. It means Coupon rate
(4.5%) > r d (4%), so both bonds sell at a premium. Because every bond feature of Red
brewerys bond is the same as Blue bond, except that Blue bonds mature in exactly 15
years, and Red bonds mature in 5 years (with interest paid semiannually) n Red = 10 <
n Blue = 30. Thus, Blue brewerys bonds would show the greatest price change.
b. At the markets new, lower required rate of return for these bonds, determine the
per bond price for each brewerys bonds. Which bonds price increased the most, and by
how much?
Bond price for Red brewerys bonds at lower required rate of return with interest
paid semiannually (8%/2=4%):

Subject: Corporate Finance

Individual Assignment

VB Red

(1 + rd)n - 1

INT

rd (1 + rd)n
45 x (1+0.4) 10 -1

+
+

(1 + rd)n
1000

4% (1+4%) 10

(1+4%) 10

= $ 1041
Bond price for Blue brewerys bonds at lower required rate of return with interest
paid semiannually (8%/2 = 4%):

VB Blue

(1 + rd)n - 1

INT

rd (1 + rd)n
45 x (1+4 %) 30 -1

+
+

(1 + rd)n
1000

4% (1+4%) 30

(1+4%) 30

= $ 1086
From this analysis above, it is clearly that Blue brewerys bonds would show the
greatest price change and its bonds price increased the most ($1086-$1000=$86).
5. Summer Stone is analyzing and investment. The expected one-year return on
the investment is 20%. The probability distribution of possible returns is
approximately normal with a standard deviation of 15%. (20 marks)
a. What are the chances the investment will result in a negative return?
Mean = 20%.
Standard deviation = 15%
Result in a negative return=> x<0%
P (x<0%) = NORM.DIST (0, 0.2, 0.15, TRUE)
Use NORMAL.DIST in excel P (x<0%) = 9.12%
6

Subject: Corporate Finance

Individual Assignment

b. What is the probability that the return will be greater than 10%? 50%?
- x<10%
P (x<10%) = NORM.DIST (0.1, 0.2, 0.15, TRUE) = 25.25%
P (x>10%)=100%-25.25% = 74.75%
-

x<50%

P (x<50%) = NORM.DIST (0.5, 0.2, 0.15, TRUE) = 97.72%

P (x>50%)=100%-36.9% = 2.28%
6. Barnaby Company has current assets of $800000 and current liabilities of
$500000. What effect would the following transactions have on the firms current
ratio (and state the resulting figures)? (20 marks)
current assets of $800000
current liabilities of $500000
Current ratio
Assets
Current Liabilities

Current assets
Current liabilities

=
=

800000

= 1.6

500000

a. Two new trucks are purchased for a total of $100000 in cash.

Current assets

$ 800000- $100000= $700000

Fixed assets

$100000

current liabilities

$500000
700000

Current ratio =

= 1.4.
500000

After Barnaby Company purchased two new trucks, current assets decreased
because of the decrease of cash, current liabilities did not change. Firms current ratio
7

Subject: Corporate Finance

Individual Assignment

decreased. However, the current ratio still > 1. This means companys ability to pay shortterm liabilities is high.
b. The company borrows $100000 short term to carry an increase in receivables of
the same amount.
current assets

$800000+$100000=$900000

current liabilities

$500000 + $100000 = $ 600000

800000

New Current ratio =

= 1.5.
600000

After Barnaby Company borrows $100000 short term to carry an increase in

receivables of the same amount, current assets increased because of the increase of AR
and current Liabilities increased due to the increase of accts. Payable. The firms current
ratio decreased. However, the current ratio still > 1. This means companys ability to pay
short-term liabilities is high.
c. Additional common stock of $200000 is sold and the proceeds invested in the
expansion of several terminals.
current assets

$800000

Fixed assets

$200'000

Liabilities and equity

Current liabilities

$500000

Common stock

$ 200'000

800000
Current ratio =

= 1.6.
500000
8

Subject: Corporate Finance

Individual Assignment

After Barnaby Company sold common stock of $200000 and the proceeds invested
in the expansion of several terminals, current assets did not change, and fixed assets
increased of $ 200000 because of the expansion of several terminals. Current Liabilities
did not change. The firms current ratio was the same at before. The companys ability to
pay short-term liabilities is high.
d. The company increases its account payable to pay a cash dividend of $40000 out
of cash.
Current assets

$800000

Current liabilities

$500000

Accts payable

$ 40'000

Total Current liabilities

= $500000+$40000 = $ 540000

Equity

($-40000)
800000

Current ratio =

1.48.

540000
After Barnaby Company increases its account payable to pay a cash dividend of
$40000 out of cash, Current assets did not change. Current Liabilities increased due to
the increase of account payable. The firms current ratio decreased. However, the current
ratio still > 1. This means companys ability to pay short-term liabilities is still high.