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Module 10Now we in order to go forward toward“But I think that there’s no magic to evaluating any financial asset. A financial asset means, by definition, that you lay out money now to get money back in the future. If every financial asset were valued properly, they would all sell at a price that reflected all of the cash that would be received from them forever until Judgment Day, discounted back to the present at the same interest rate.”Warren BuffettWe go back to Fixed Income InstrumentsThe coupon rate of a bond is: The % of the face that the bond pays in interest each year.On January 1, 2020, Isabella Company of Las Vegas, Nevada, issues $100,000 of 8% bonds. The bonds pay interest annually and mature in three years. Interest is to be paid on December 31 of each year. (First interest is to be paid 12/31/20)Remember these are unreal examples! Bonds mature in many, many years, not 3! AppliedPrincipalDatePaymentInterest 8%PrincipalBalance1/1/20120100,000.00 12/31/208,000.00 8,000.00 0.00 100,000.00 12/31/218,000.00 8,000.00 0.00 100,000.00 12/31/228,000.00 8,000.00 0.00 100,000.00 12/31/22100,000.00 100,000.00 0.00 What if by the time it got to the market, interest rates had risen to 10%?The purpose of education isn’t knowledge, it is action.Kirch’s 3rd law of the Universe…. You Can’t Change the Deal!!!!How much does Isabella receive?2nd clr tvm8,000 pmt 100,000 fv 3 N10 I/YCpt pv95,026.30Bonds issued for less than the face are said to be issued at discount.Amortize the bond AppliedPrincipalDatePaymentInterest 10%PrincipalBalance1/1/2095,026.30 12/31/208,000.00 9,502.63 (1,502.63)96,528.93 12/31/218,000.00 9,652.89 (1,652.89)98,181.82 12/31/228,000.00 9,818.18 (1,818.18)100,000.01 12/31/22100,000.00 100,000.00 0.01 LINK Excel.Sheet.8 "C:\\Users\\kirch.OHIO\\Desktop\\MFE Summer\\Isabella Bonds.xls" Discount!R47C1:R53C5 \a \f 5 \h \* MERGEFORMAT Show how the Bond Accounts appear on the Balance Sheet for each year.What about current portion?Balance Sheet202020212022Bond Pay 100,000 100,000 Less Discount(3,471)(1,818)?96,529 98,182 In 2022 the company needs to repay the principal. Where will it get the money? They have to roll it over when it is due. So if a company plans to issue new debt to cover debt that is coming due and they have the capability of doing so, then no portion of the debt is considered current portion even though it is due next year.What if the current interest rate was 6%?(3rd law applies!!!)calculate issuance amount, and amortize Bonds sold for an amount higher than the face are said to sell at a premium. LINK Excel.Sheet.8 "C:\\Users\\kirch.OHIO\\Desktop\\MFE Summer\\Isabella Bonds.xls" "Premium!R2C2:R18C6" \a \f 5 \h \* MERGEFORMAT Are you listening, or just reloading?A zero coupon bond isAlso called a Deep Discount BondWhy issue/buy?For tax purposes, if you have a zero coupon bond, you have to report the interest each year as income even though you don’t receive it. This is known as the doctrine of Constructive Receipt.Investors who expect interest rates to decreaseCompanies that expect interest rates to increaseClaire Co. issues a $100,000 zero on December 31, 2018, interest rate 10% per annum, bond is due in three years. How much do they get?Amortize it What if the bonds had been issued so the repayment is in equal payments? Do all three.Par10%96,498.19 PV6%Now, go back to the original problems. 8% interest only, $100,000, 3 year bonds.If the bonds were issued on April 1st, 2020, what would be the interest expense for the first year? The second year?At Par, 8%, AppliedPrincipalDatePaymentInterest 8%PrincipalBalance1/1/20120100,000.00 12/31/208,000.00 8,000.00 0.00 100,000.00 12/31/218,000.00 8,000.00 0.00 100,000.00 12/31/228,000.00 8,000.00 0.00 100,000.00 12/31/22100,000.00 100,000.00 0.00 Interest expense for year 1 = 9/12 X 8,000 = $6,000Interest expense for year 2 = $8,000, (((3/12) X 8,000) + ((9/12) X 8,000))At 10% AppliedPrincipalDatePaymentInterest 10%PrincipalBalanceIssue (4/01/20)95,026.30 Year 1(03/31/21)8,000.00 9,502.63 (1,502.63)96,528.93 Year 2 (3/31/228,000.00 9,652.89 (1,652.89)98,181.82 Year 3 (3/31/23)8,000.00 9,818.18 (1,818.18)100,000.01 Year 3 Principal(3/31/23)100,000.00 100,000.00 0.01 So Interest expense for year 1 = 9/12 X 9,502.63 = $7,126.97Interest expense for year 2 = (((3/12) X 9,502.63) + ((9/12) X 9,652.89))= 2,375.66 + 7,239.67= $9,615.33At 6%So interest expenseYear 1 = 9/12 X 6,320.76 = $4,740.57Year 2 = 3/12 X 6,320.76 + 9/12 X 6,220.01 = 1,580.19 + 4,665.01 = $6,245.20 Module 10, HomeworkPart 1Problem 1 Brynnie Company issues a $100,000 on 12/31/19, 15%, bond that matures in 3 years. Interest is paid on December 31st of each year. Calculate how much would be received and amortize this bond issue if it was priced to yield: 10% 15% 20%Problem 2 Charleigh Company issued 8% zero on 12/31/19, due in 3 years, face amount of $100,000. How much would you pay? Amortize it. Problem 3 Ryan Company issues a $100,000 on 8/31/19, 10%, bond that matures in 5 years. Interest is paid on August 31st of each year. How much would you pay to yield: 8% 10% 14% Amortize each of theseProblem 4 Still Ryan Company - How about a zero issued on 5/31/19, due in 4 years, face amount of $100,000. Current market rates are 11%. How much would you pay?Amortize it. Problem 5 What if the Isabella bonds were issued on Oct 1, and called for equal payments?What would be the interest expense for 2020 and 2021 under the following “sold to yield” scenarios?Par10% 6%Part 2You have seen an ad for a used Mercedes in the Athens Messenger. The car is for sale for $40,000. You believe you could make a buck by renting the car out. You figure you could rent the car to the semi-rich on a daily basis for three years. You think you could rent the car for $120 per day for the first year and $100 per day the second year and $60 per day for the third year. You expect that the car will be rented out about 80% of the time the first year, 70% of the time the second year and 60% of the time for the third year. At the end of the third year, you figure you can sell the car for $20,000. You estimate that the repairs and maintenance on the car will be about $1,200 for the first year, $2,000 the second year and $3,000 the third year. Licenses and fees will run $1,800 per year for all three years. You will pay a rental company 16% of the gross rents you receive each year to take care of all the paper work and the renting of the car to the students. How much can you pay for the car today and make 20% on your investment? Mercedes??????Year 1?Year 2?Year 3?Rents 35,040 ????????????????????Cash Expenditures:?????? Repairs & Maintenance?????? Licenses & Fees?????? Rental Company Fees??????Total Cash Expenditures?????????????Net Cash Flow????? ................
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