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Question 1
Lance Armstrong Inc. manufactures cycling equipment. Recently the vice president of
operations of the company has requested construction of a new plant to meet the
increasing demand for the company's bikes. After a careful evaluation of the request,
the board of directors has decided to raise funds for the new plant by issuing
$2,000,000 of 11% term corporate bonds on March 1, 2007, due on March 1, 2022, with
interest payable each March 1 and September 1. At the time of issuance, the market
interest rate for similar financial instruments is 10%.
Instructions
As the controller of the company, determine the selling price of the bonds.
Marks 10
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Question 2
Homer Simpson Inc., a manufacturer of steel school lockers, plans to purchase a new
punch press for use in its manufacturing process. After contacting the appropriate ven-
dors, the purchasing department received differing terms and options from each vendor.
The Engineering Department has determined that each vendor's punch press is
substantially identical and each has a useful life of 20 years. In addition, Engineering
has estimated that required year-end maintenance costs will be $1,000 per year for the
first 5 years, $2,000 per year for the next 10 years, and $3,000 per year for the last 5
years. Following is each vendor's sale package.
Vendor A: $45,000 cash at time of delivery and 10 year-end payments of $15,000
each. Vendor A offers all its customers the right to purchase at the time of sale a
separate 20-year maintenance service contract, under which Vendor A will perform all
year-end maintenance at a one-time initial cost of $10,000.
Vendor B: Forty semiannual payments of $8,000 each, with the first installment due
upon delivery. Vendor B will perform all year-end maintenance for the next 20 years at
no extra charge.
Vendor C: Full cash price of $125,000 will be due upon delivery.
Instructions
Assuming that both Vendor A and B will be able to perform the required year-end
maintenance, that Simpson's cost of funds is 10%, and the machine will be purchased
on January 1, from which vendor should the press be purchased?
Marks 20
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Question 3
Sally Brown died, leaving to her husband Linus an insurance policy contract that
provides that the beneficiary (Linus) can choose any one of the following four options.
(a) $55,000 immediate cash.
(b) $3,700 every 3 months payable at the end of each quarter for 5 years.
(c) $18,000 immediate cash and $1,600 every 3 months for 10 years, payable at the
beginning of each 3-month period.
(d) $4,000 every 3 months for 3 years and $1,200 each quarter for the following 25
quarters, all payments payable at the end of each quarter.
Instructions
If money is worth 10% per year, compounded quarterly, which option would you
recommend that Linus exercise?
Marks 15
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Question 1
Miles Davis is a financial executive with Starship Enterprises. Although Miles has not
had any formal training in finance or accounting, he has a "good sense" for numbers
and has helped the company grow from a very small company ($500,000 sales) to a
large operation ($45 million in sales). With the business growing steadily, however, the
company needs to make a number of difficult financial decisions in which Miles feels a
little "over his head." He therefore has decided to hire a new employee with "numbers"
expertise to help him. As a basis for determining whom to employ, he has decided to
ask each prospective employee to prepare answers to questions relating to the
following situations he has encountered recently. Here are the questions.
(a) In 2005, Starship Enterprises negotiated and closed a long-term lease contract
for newly constructed truck terminals and freight storage facilities. The buildings
were constructed on land owned by the company. On January 1, 2006, Starship
took possession of the leased property. The 20-year lease is effective for the
period January 1, 2006, through December 31, 2025. Advance rental payments of
$800,000 are payable to the lessor (owner of facilities) on January 1 of each of
the first 10 years of the lease term. Advance payments of $300,000 are due on
January 1 for each of the last 10 years of the lease term. Starship has an option
to purchase all the leased facilities for $1 on December 31, 2025. At the time the
lease was negotiated, the fair market value of the truck terminals and freight
storage facilities was approximately $7,200,000. If the company had borrowed the
money to purchase the facilities, it would have had to pay 10% interest. Should
the company have purchased rather than leased the facilities?
Marks 15
Roll Number:_____________________
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Question 2
Sadu Inc. owns and operates a number of hardware stores in the Hagerstown region.
Recently the company has decided to locate another store in a rapidly growing area of
Maryland. The company is trying to decide whether to purchase or lease the building
and related facilities.
Purchase: The company can purchase the site, construct the building, and purchase all
store fixtures. The cost would be $1,650,000. An immediate down payment of $400,000
is required, and the remaining $1,250,000 would be paid off over 5 years at $300,000
per year (including interest). The property is expected to have a useful life of 12 years,
and then it will be sold for $500,000. As the owner of the property, the company will
have the following out-of-pocket expenses each period.
Property taxes (to be paid at the end of each year) $40,000
Insurance (to be paid at the beginning of each year) 27,000
Other (primarily maintenance which occurs at the end of each year) 16,000
$83,000
Lease: M&T Bank has agreed to purchase the site, construct the building, and install
the appropriate fixtures for Sadu Inc. if Sadu will lease the completed facility for 12
years. The annual costs for the lease would be $240,000. Sadu would have no
responsibility related to the facility over the 12 years. The terms of the lease are that
Sadu would be required to make 12 annual payments (the first payment to be made at
the time the store opens and then each following year). In addition, a deposit of
$100,000 is required when the store is opened. This deposit will be returned at the end
of the twelfth year, assuming no unusual damage to the building structure or fixtures.
Currently the cost of funds for Sadu Inc. is 10%.
Instructions
Which of the two approaches should Sadu Inc. follow?
Marks 20
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Sadu Inc. should lease the facilities because the present

value of the
costs for leasing the facilities, $1,866,951, is less than the
present
value of the costs for purchasing the facilities,
$1,961,856.
Roll Number:_____________________