See File Attached.
Midterm_S20 2 1. Raymond Kroncke has just retired at age 65. He plans to fund his retirement income using a Roth IRA (a non-taxable retirement account), which currently has a value of $3,000,000. Mr. Kroncke expects to live for 18 more years. During retirement, he plans to withdraw income from his retirement account once every 18 months, with the first withdrawal to occur immediately and the last withdrawal occurring 18 months prior to his death (at age 83). Mr. Kroncke is confident that his retirement account will earn a semiannually compounded return of 6.4 percent per year. Prices are expected to increase at a semiannually compounded rate of 2.8 percent per year due to inflation. Assuming that Mr. Kroncke wants the purchasing power of his periodic withdrawals/income to remain constant during retirement, determine the maximum initial withdrawal that can be made from the retirement fund assuming there is one withdrawal every 18 months, with the first withdrawal to occur immediately, and that no withdrawal occurs at the end of the 18-year retirement period. (15 points) 3 2. Red Hawk Property Partners ( RHPP ) is evaluating a proposal to purchase two idle manufacturing facilities located near Burbank, Oklahoma. The combined cost of purchasing these properties would be $20 million. Each facility has 3000 amps of 480 volt 3 phase electrical power and close proximity to the air cargo facilities at the Osage regional airport. However, an immediate expenditure of $8 million dollars will be required to begin the installation of cleanrooms in each facility and to bring the electrical wiring into compliance with local building codes. The total time required to upgrade and complete the sales of the two facilities is four years. The CFO for RHPP projects that at the end of two years the first facility can be sold for $25 million. The second facility, whose configuration is somewhat less desirable, will take four years to sell, with an expected selling price of $15 million. Revisions to the tax code intended to stimulate the economy exempt all profits related to renovation and sale of idle manufacturing capacity from all State and Federal taxes. Assuming the date 2 project cash flows can be reinvested at an annual rate of 2.5 percent: a. determine the internal rate of return for the project. (6 points) b. determine the reinvested rate of return for the project. (6 points) c. concisely explain why the reinvested rate of return is greater than or less than the internal rate of return for the project (no points will be awarded for a simple comparison of the internal rate of return and the reinvested rate of return). (5 points) 4 3. On March 4, 2020 Skiatook National Bank issued $5 billion of “step-up” bonds having 18 years to maturity. The step-up bonds, which have a par value of $1000, make semiannual coupon payments on March 4 and September 4. Although the initial coupon rate is only 2.0 percent, the coupon rate will be stepped up to 3.5 percent following the March 4, 2027 coupon payment and remain constant at 3.5 percent until the bond matures on March 4, 2038. Assuming the required yield to maturity for all bonds issued by Skiatook National Bank is currently 1.8 percent, determine the price of the step-up bonds on March 4, 2020. (15 points) 5 4. Panel del Sol Inc. (PdS) is a recently incorporated manufacturer of octagonal solar panels. The company has yet to reach profitability due to both the unsightly appearance of its solar panels and the ability of its Chilean competitors to produce an identical product at half the cost. Since high-cost solar panels are PdS’s only product, failure to reduce production costs during the next year is likely to force the company to default on its outstanding issue of zero coupon bonds, having one year to maturity and a face value of $1000. Although the CEO is confident that PdS can achieve the necessary cost reductions, there is a 15 percent probability that the firm will run out of money during the next year and file for Chapter 11 bankruptcy protection, in which case bondholders will lose 55 percent of their investment, recovering only $450 of the promised $1000 payment of principal at maturity. Zero coupon bonds issued by the U.S. government having a par value of $1000 and one year to maturity are currently selling at a price of 98.23 (percent of their par value). Assuming that all interest rates should be quoted on an annually compounded basis and that investors value risky bonds by discounting their expected payoff at the risk-free interest rate, compare the annual yield to maturity for the zero coupon bonds issued by the government with the promised yield to maturity for Panel del Sol’s bonds. (15 points) 6 5. Standard Rendering is considering the replacement of a battery of 5 Expeller presses, which are used to separate bleachable fancy tallow from meat and bone meal. Dupps Manufacturing has offered to sell 5 brand new Mega 200 Expeller presses to Standard for $200,000 (total cost). The specifications for the Mega 200 include a case hardened worm assembly and a double reduction gearbox. The new presses can be depreciated to a zero salvage value over 4 years using straight-line depreciation. If required yearly maintenance, with a before-tax total yearly cost of $20,000, is performed on schedule at the end of each year of operations, the new presses will have an economically useful life of 9 years. The total projected future maintenance costs and salvage values for the 5 older Expeller presses currently being used by Standard Rendering are, Before-Tax After-Tax Year Maintenance Salvage 0 $25,000 $40,000 1 32,000 38,500 2 40,000 30,800 3 60,000 16,500 Standard Rendering has a 30 percent corporate tax rate and a required return of 10 percent. Assuming the purchase price and maintenance costs for a new Mega 200 Expeller press will remain constant, determine when the old presses should be replaced. (22 points) 7 6. Anna Schuman just purchased a risk-free US Treasury note having 3 years to maturity and an annual coupon rate of 7.0 percent. Assume that the coupon/interest payments for Treasury notes are made once per year (coupon payments occur annually). The annualized yield to maturity for a risk-free zero coupon bond that matures in one year is 2.00 percent. The annualized forward interest rate for a 1-year period that begins in 1 year is 2.75 percent, while the forward rate of interest for a 2-year period that begins in 1 year is 3.00 percent, a. determine the annualized yield to maturity for risk-free zero coupon bonds that mature respectively in 2 years and in 3 years (4 points) b. determine the annual coupon rate for a U.S. Treasury note having a market price of $1038.46, three years to maturity and a par value of $1000. (4 points) c. determine the current market price for a Treasury note having 3 years to maturity and an annual coupon rate of 7.0 percent (with coupons paid annually). (4 points). d. determine the annualized yield to maturity for the 7.0 percent (coupon) Treasury note having 3 years to maturity (4 points)