1. Spiess Corporation\'s 12%, $1000 bonds mature in 10 years. The company can ca
ID: 2639670 • Letter: 1
Question
1. Spiess Corporation's 12%, $1000 bonds mature in 10 years. The company can call the bonds in five years if it pay bondholders a call premium of 12 percent. What should Spiess's bonds sell for if investors expect them to be called in five years and the interest rate is 9% ?
A. 1195.96 B. 840.45 C. 2120 D. 1194.68
2. Joshua Trucking has chosen a new software package tied to seatellite global positioning system(GPS), in order to mnitor its fleet. The software will be outdated after three years and replaced. The software vendor has given Joshua Trucking the choice of buying the software for 65000 or leasing it for an annual payment $25000. To attract customers, the GPS vendor allows lease payments at year-end. The firm has decided to purchase the vendor's service contract under either option. Assume that dereciation is on a straight-line basis, Joshua Trucking's cost of obtaining funds is nine percent, and the firm is in the 34 percent tax bracket. Should it borrow and buy or lease the GPS software?
Explanation / Answer
Answer 1 : Option D is correct i.e. 1194.68
For 12% bond it will yield $ 120 per annum for 5 years. The present value of the annuity calculated at 9% interest rate is $ 466.76. Also you will be getting a 12% call premium which will give you $ 1,120 as recall value and calculating the present value of $ 1120 at 9% interest rate for 5 years gives you present value of $ 727.92. So the total amount comes out to be $ 1,194.68 ( $ 727.92 + $ 466.76).
Answer 2. Leasing in this case is a better option.
Option 1 is buying calculated as follows:
Net pay out would be $ 65,000 for GPS and the depreciation will be $ 21,666.67 each year which will help in saving tax of $ 7,366.68. Total tax saving will be $ 22,100. The present value of tax saving is $ 18,647.2. The total cost comes out to be $ 46,352.8 ( $ 65,000 - $ 18,647.2).
Option 2 is leasing calculated as follows:
You have to pay $ 25,000 at the end of each year. The total present value of $ 25,000 payment for three years comes out to be $ 63,282.37. The total tax saving will be $ 8,500 each year that is $ 25,500. The present value of $ 25,500 at (% for three years comes out to be $ 21,516. The effective cost comes out to be $ 41,766 ( $ 63,282.37 - $ 21,516)
Hence, the effective cost as per leasing option is less. Thus it is a better option.
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