Timor Inc Recently Issued Non-Callable Bonds That Mature In
Timor Inc Recently Issued Non Callable Bonds That Mature In 8 Years
Timor Inc. has recently issued non-callable bonds with a face value (par) of $5,000 and an annual coupon rate of 6.0%. The bonds will mature in 8 years, and the current market interest rate is 5.4%. To determine the appropriate selling price of these bonds, we need to calculate the present value of the bond's future cash flows—namely, the annual coupon payments and the face value at maturity—discounted at the current market rate.
The bond's annual coupon payment is calculated as 6.0% of the par value:
\[ \text{Coupon Payment} = 0.06 \times \$5,000 = \$300 \]
The present value (PV) of the bond is the sum of the present value of the annuity of coupon payments and the present value of the face value:
\[ \text{Price} = PV_{\text{coupons}} + PV_{\text{face}} \]
Using a financial calculator or spreadsheet, input the following:
- Future value (FV) = $5,000
- Annual coupon payment (PMT) = $300
- Number of periods (N) = 8
- Market interest rate (i) = 5.4%
Calculations show that the bond should sell at a premium relative to its par value because the coupon rate (6.0%) exceeds the market rate (5.4%). The approximate price comes to around $5,170, reflecting the present value of future cash flows discounted at the market rate.
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DJJ Company's Cost of Equity Using CAPM
DJJ Company's beta is 1.20, the risk-free rate is 4.0%, and the market risk premium is 6.0%. The Capital Asset Pricing Model (CAPM) calculates the firm's cost of equity as:
\[ \text{Cost of Equity} = R_f + \beta \times (R_m - R_f) \]
where \( R_f \) is the risk-free rate, and \( R_m - R_f \) is the market risk premium.
Plugging in the values:
\[ \text{Cost of Equity} = 4.0\% + 1.20 \times 6.0\% = 4.0\% + 7.2\% = 11.2\% \]
Thus, DJJ's cost of equity from retained earnings is approximately 11.2%.
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Most Informative Ratio for Managing Short-term Debts
The ratio most indicative of a firm's ability to manage short-term debts is the Current Ratio. This ratio compares current assets to current liabilities, providing insights into the company's short-term liquidity and operational efficiency. A higher current ratio suggests the company can comfortably meet its short-term obligations, whereas a lower ratio could indicate potential liquidity issues.
Other ratios:
- Inventory Turnover Ratio indicates how efficiently inventory is managed but not overall short-term liquidity.
- Profit Margin reflects profitability rather than liquidity.
- Price-Earnings Ratio provides valuation metrics but is less relevant for liquidity management.
Therefore, the Current Ratio is the most comprehensive indicator of a company's short-term debt management capability.
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Expected Rate of Return Based on Risk Components
Given:
- Real risk-free rate, \( R^* = 2.15\% \)
- Expected inflation rate, \( IP = 1.10\% \)
- Maturity risk premium (MRP) = 0.25%
- Time horizon = 3 years
The expected nominal rate of return can be approximated by summing these components, assuming no cross-product effects:
\[ R_{expected} = R^* + IP + \text{MRP} \]
\[ R_{expected} = 2.15\% + 1.10\% + 0.25\% = 3.50\% \]
Therefore, the expected rate of return on the 3-year Treasury security is approximately 3.50%.
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Profit Margin of Panel Corp
Panel Corp's sales last year were $160,000, and net income was $20,000. The profit margin measures how much profit the company generates from each dollar of sales:
\[ \text{Profit Margin} = \frac{\text{Net Income}}{\text{Sales}} \]
\[ \text{Profit Margin} = \frac{\$20,000}{\$160,000} = 0.125 \text{ or } 12.5\% \]
This indicates that Panel Corp earned 12.5 cents profit for every dollar of sales.
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Net Income Calculation for Linver Inc.
During 2011, Linver Inc. paid dividends of $23,000, and its ending retained earnings were $245,000, up from $165,000 at the beginning of the year. The change in retained earnings reflects net income less dividends paid:
\[ \text{Change in Retained Earnings} = \text{Ending RE} - \text{Beginning RE} \]
\[ \text{Net Income} = \text{Dividends} + \text{Change in RE} \]
\[ \text{Net Income} = \$23,000 + (\$245,000 - \$165,000) = \$23,000 + \$80,000 = \$103,000 \]
Thus, Linver Inc. earned approximately $103,000 in net income during the year.
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Time to Double Investment at 6% Interest
Using the Rule of 72 or financial calculator, the approximate time to double an investment at an interest rate of 6% compounded annually is:
\[ \text{Time} = \frac{72}{6} = 12 \text{ years} \]
Alternatively, with a financial calculator or spreadsheet, the precise time it takes $10,000 to double at 6% interest annually is about 11.9 years.
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References
- Brigham, E. F., & Ehrhardt, M. C. (2016). Financial Management: Theory & Practice. Cengage Learning.
- Damodaran, A. (2012). Investment Valuation: Tools and Techniques for Determining the Value of Any Asset. Wiley.
- Ross, S. A., Westerfield, R., & Jordan, B. D. (2019). Fundamentals of Corporate Finance. McGraw-Hill Education.
- Gitman, L. J., & Zutter, C. J. (2015). Principles of Managerial Finance. Pearson.
- Fabozzi, F. J. (2013). Bond Markets, Analysis and Strategies. Pearson.
- Higgins, R. C. (2012). Analysis for Financial Management. McGraw-Hill Education.
- Meigs, S. L., Meigs, R. F., & Meigs, M. (2017). Financial Management: A Practical Approach. Cengage Learning.
- Palepu, K. G., & Healy, P. M. (2012). Business Analysis & Valuation: Using Financial Statements. Cengage Learning.
- EIectronic resources from Investopedia and financial analysis databases for up-to-date market data and ratios.
- U.S. Department of the Treasury. (2023). Treasury yield curve rates. https://home.treasury.gov/