Instructions For Your Probationary Period At Cosmo K Manufac

Instructions your Probationary Period At The Cosmo K Manufacturing Grou

Your probationary period at the Cosmo K Manufacturing Group continues. Your supervisor, Gerry, assigns you a project each week to test your competence in finance. This week, Gerry has asked you to evaluate several investment opportunities available to the company. Your instructions are to consider each situation independently of the others, unless otherwise indicated.

Evaluating Investment Opportunities

Consider the following situations and answer the related questions:

Your company has the opportunity to make an investment that promises to pay $24,000 after 6 years. If your company has a required return of 8.5% on this type of investment, what is the maximum amount that the company should pay for the investment? Explain your answer.

In the previous scenario, assume that your company negotiated a deal where it would pay $12,000 for the investment and receive a payment of $24,000 at the end of 7 years. What is the IRR on this investment? Should the company make the investment? Explain your answer.

Another investment opportunity available to your company involves the purchase of some common stock from Zorp Corporation. The company has asked you to evaluate the stock, which paid a dividend of $4.25 last year and is currently selling for $36 per share. If your company decides to buy the stock, the stock will be held for 5 years and then sold. The growth rate on the stock is constant at 3% per year, and your company's required return on the stock would be 11%. What is the maximum price per share that your company should pay for the stock?

Zorp Corporation also has some bonds for sale that your company is considering. These bonds have a $1,000 par value and will mature in 16 years. The coupon rate on the bonds is 5% paid annually, and they are currently selling for $987 each. The bonds are call protected for the next 4 years, and after this period, they are callable at 105. On the basis of this information, answer the following questions: What is the YTM on these bonds? If the bonds are called immediately after the call protection period, what would be the yield to call (YTC)? If the bonds paid interest semiannually instead of annually, would the YTC, the YTM, or both change? Explain your answers.

Paper For Above instruction

Evaluating Investment Opportunities for the Cosmo K Manufacturing Group

Introduction

In the dynamic landscape of corporate finance, making informed investment decisions is crucial for corporate growth and sustainability. This paper evaluates several investment opportunities available to Cosmo K Manufacturing Group, applying core financial principles such as present value, internal rate of return, stock valuation, and bond yield calculations. Each scenario is analyzed independently, providing insights into optimal investment strategies aligned with the company's required returns and risk considerations.

1. Investment with a Future Payoff

The first proposed investment promises a payout of $24,000 after 6 years. To determine the maximum price the company should pay today, we utilize the present value (PV) formula, which discounts future cash flows at the company's required rate of return (discount rate). The formula is:

P V = F / (1 + r)^n

Where F = future value ($24,000), r = discount rate (8.5%), n = number of years (6).

Calculating PV:

P V = 24,000 / (1 + 0.085)^6 = 24,000 / 1.085^6 ≈ 24,000 / 1.677 ≈ $14,312.02

Therefore, the maximum amount the company should pay today is approximately $14,312.02. Paying more would reduce the expected return below the company's required threshold.

2. Investment with Negotiated Terms and IRR Calculation

In the negotiated deal, the company invests $12,000 and receives $24,000 after 7 years. The internal rate of return (IRR) is the discount rate that makes the present value of future cash flows equal to the initial investment:

0 = -12,000 + 24,000 / (1 + IRR)^7

Rearranged, IRR is calculated as:

IRR = (F / P)^{1/n} - 1

Where F = future value ($24,000), P = initial payment ($12,000), n = 7 years.

Calculating IRR:

IRR = (24,000 / 12,000)^{1/7} - 1 = 2^{1/7} - 1 ≈ 1.10409 - 1 ≈ 0.10409 or 10.41%

The IRR of approximately 10.41% is slightly below the company's required return of 11%. Given this, the company should consider whether the investment's risk profile or strategic value justifies proceeding despite the IRR being marginally below the threshold.

3. Stock Valuation of Zorp Corporation

The stock valuation is based on the Gordon Growth Model (Dividend Discount Model for a growing perpetuity):

P = D1 / (r - g)

Where D1 = dividend next year = last year's dividend (4.25) (1 + g) = 4.25 1.03 ≈ $4.3775.

r = required return = 11%, g = growth rate = 3%.

Calculating the maximum price:

P = 4.3775 / (0.11 - 0.03) = 4.3775 / 0.08 ≈ $54.72

Since the current market price is $36, the stock appears undervalued and could be a good buy at or below this calculated maximum price, considering the company's investment horizon and risk profile.

4. Bond Analysis: YTM and YTC

The bonds have a face value of $1,000, a coupon rate of 5% paid annually, and are trading at $987. The bond's current yield (CY) can be calculated as:

CY = annual coupon / current price = 50 / 987 ≈ 5.07%

However, to estimate the yield to maturity (YTM), we use the approximate formula or a financial calculator since the exact calculation involves solving for r in:

$987 = 50 * [1 - (1 + r)^{-16}] / r + 1,000 / (1 + r)^{16}

Using a financial calculator or Excel's RATE function yields a YTM close to 5.10%, considering the small premium over face value.

The bonds are callable after 4 years at 105, i.e., at $1,050. If called immediately after call protection, the yield to call (YTC) can be estimated as:

YTC = [Coupon payment + (Call price - current price)/number of years to call] / [(Call price + current price)/2]

Assuming a 4-year call and using the approximate yields gives a YTC close to 5.25%, slightly higher than YTM due to call premium.

For semiannual interest payments, both YTM and YTC would change, because the payment frequency affects the effective periodic rate, resulting in different compounding effects. Specifically, the semiannual payments would double the payment frequency, impacting the calculations of present value and yield estimations, leading to higher precision in these metrics.

Conclusion

These analyses demonstrate the importance of using appropriate financial formulas and tools—such as present value calculations, IRR, and bond yield formulas—to inform sound investment decisions. Investing prudently requires understanding the risks, return expectations, and market conditions associated with each opportunity, ensuring alignment with corporate financial strategy and risk tolerance.

References

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