Part One: Time Value of Money

You just won the lottery!  The lottery claims that your prize is $1,500,000 after taxes.  You have the choice to receive the lump sum amount one year from today in the amount of $1,500,000, OR, you can receive payments of $170,000 per year for the next 10 years, beginning one year from today. If your required rate of return is 8%, which option would be preferred?

Required:

• Ignoring taxes and based on the TVM alone, evaluate the two options.  Use a Microsoft Excel spreadsheet to calculate the lump sum payment you would receive one year from today. Calculate the total payments you would receive over the next 10 years. Which option is preferred? Justify your response.

Part Two: Financial Information

Bob and Sally just purchased Bosall Industries and have asked for your help in the financial area.  They have several questions about the financial information provided from the previous owners, as summarized below.

Sally has discovered several types of bonds on the books of Bosall.  They have asked you describe each type of bond, how they are traded, and where they are traded.  They would also like to know the advantages and disadvantages of each type of bond to the seller and to the buyer.  The types of bonds in question are:

• Junk Bonds
• Zero Coupon Bonds
• Junk Bonds
• Convertible Bonds
• Municipal Bonds

Sally is also curious about some terminology she saw in her readings.  Specifically, she would like you to explain the meaning of the following:

• Interest rate risk
• Reinvestment rate risk
• Current Yield
• Indenture

Part Three: Financial Calculations

Bob is concerned with the current value and the yields of several bonds the company is holding as investments.  He has asked you the following questions regarding these holdings:

1. 1. A Carbost Inc. 10 year bond was purchased 2 years ago at par, for $1,000, and has a coupon rate of 7.5%.  The yield to maturity on this bond is 10%.  Bob would like to know the current price or value of this bond.

1. 1. A 20-year bond that the company purchased 5 years ago at a par value of $1,000 may be called in one year at $1,050. The bond currently sells for $1,100 and has a coupon rate of 6%.  Bob would like to know the following:

1. 1. What is the bond's yield to maturity?
   2. What is the bond's yield to call?