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2

$10- $30

**Question 1:** If the pension plan invests $95 million today in 10-year US Treasury bonds (riskless investment with guaranteed return) at an interest rate of 3.5 percent a year, how much will it have by the end of year 10?

**Question 2:** If the pension plan needs to accumulate $14 million in 13 years, how much must it invest today in an asset that pays an annual interest rate of 4 percent?

**Question 3:** How many years will it take for $197 million to grow to be $554 million if it is invested in an account with a quoted annual interest rate of 5 percent with monthly compounding of interest?

**Question 4:** The pension plan also invests in physical assets. It is considering the purchase of an office building today with the expectation that the price will rise to $20 million at the end of 10 years. Given the risk of this investment, there should be a yield of 10 percent annually on this investment. The asking price for the lot is $12 million. What is the annual yield (internal rate of return) of the investment if the purchase price is $12 million today and the sale price 10 years later is $20 million? Should the pension plan buy the office building given its required rate of return?

**Question 5a:** The pension plan is also considering investing $70 million of its cash today at a 3.5 percent annual interest for five years with a commercial bank. How much will the $70 million grow to at the end of 5 years?

**Question 5b:** Now take the amount of your answer in Ques 5a, and assume this money is invested in an annuity due with the first payment made at the beginning of the 6th year. The annuity due makes a total of 15 yearly (equal) payments. How much will the annual payments be from years 6 to 20, if the rate at which these payments are discounted is also 3.5 percent?

**Question 6:** The pension plan is about to take out a 10-year fixed-rate loan for the purchase of an information management system for its operations. The terms of the loan specify an initial principal balance (the amount borrowed) of $4 million and an APR of 3.75 percent. Payments will be made monthly. What will be the monthly payment? How much of the first payment will be interest, and how much will be principal? Use the Excel PMT function to provide the answers to these questions.

Submit your Time Value of Money Report and Calculations to the dropbox below. Be sure to show your calculations in Excel and provide a narrative analysis in PowerPoint. Your narrative analysis should summarize the results of your analysis and make recommendations for the benefit of the company.

Before you submit your assignment, review the competencies below, which your instructor will use to evaluate your work. A good practice would be to use each competency as a self-check to confirm you have incorporated all of them in your work.

- 3.1 Identify numerical or mathematical information that is relevant in a problem or situation.
- 3.2 Employ mathematical or statistical operations and data analysis techniques to arrive at a correct or optimal solution.
- 3.3 Analyze mathematical or statistical information, or the results of quantitative inquiry and manipulation of data.
- 3.4 Employ software applications and analytic tools to analyze, visualize, and present data to inform decision-making.
- 10.3 Determine optimal financial decisions in pursuit of an organization's goals.
- 10.4 Make strategic managerial decisions for obtaining capital required for achieving organizational goals.

· 2 Basic Capital Budget Analysis

· As the manager of the pension fund, you are frequently targeted by software companies peddling investment simulation software. You have finally narrowed down your choice to two applications. You need to analyze the options by calculating NPV, IRR and Payback Period based on their purchase price and savings to your company over time. Your staff has prepared a cash-flow table to help you. Year zero shows the purchase price of each application, and the figures listed for years 1-3 represent the savings to the company in successive years.

**Year**

**Application I**

**Application II**

0 (today)

-$1.5 million

-$1 million

1

$0.8 million

$0.5 million

2

$0.7 million

$0.24 million

3

$0.3 million

$0.6 million

You are considering three possible scenarios.

**Question 7:** If the payback period is two years, which application should be selected?

**Question 8:** If the required rate of return is 15 percent, which application should be selected?

**Question 9:** If the selection criterion is IRR, which application should be selected?

Respond to the questions 7, 8, and 9 above by submitting a single, integrated report that shows your supporting data and calculations. Finally, provide a recommendation and rationale for purchasing either Application I or Application II.

Submit your Basic Capital Budget Analysis Report and Calculations to the dropbox below. Be sure to show your calculations in Excel and provide a narrative analysis in PowerPoint. Your narrative analysis should include your recommendation and rationale for purchasing either Application I or Application II.

Before you submit your assignment, review the competencies below, which your instructor will use to evaluate your work. A good practice would be to use each competency as a self-check to confirm you have incorporated all of them in your work.

- 3.1 Identify numerical or mathematical information that is relevant in a problem or situation.
- 3.2 Employ mathematical or statistical operations and data analysis techniques to arrive at a correct or optimal solution.
- 3.3 Analyze mathematical or statistical information, or the results of quantitative inquiry and manipulation of data.
- 3.4 Employ software applications and analytic tools to analyze, visualize, and present data to inform decision-making.
- 10.3 Determine optimal financial decisions in pursuit of an organization's goals.
- 10.4 Make strategic managerial decisions for obtaining capital required for achieving organizational goals.

3 Capital Budgeting—Decide Which Projects to Complete

Another one of your responsibilities as CFO is to determine the suitability of new and current products. Your CEO has asked you to evaluate Android01. That task will require you to combine data from your production analysis from Project 2 with data from a consultant's study that was done last year. Information provided by the consultant is as follows:

- initial investment: $120 million composed of $50 million for the plant and $70 million net working capital (NWC)
- yearly expenses from year 1 to year 3: $30 million
- yearly revenues from year 1 to year 3: $0
- yearly expenses from year 4 to year 10: $55 million
- yearly expected revenues from year 4 to year 10: $95 million
- yearly expenses from year 11 to year 15: $60 million
- yearly expected revenues from year 11 to year 15: $105 million

- You are to calculate NPV using the “expected values”. The actual cash flow may be variable (risky) and that is the reason why he discount rate is greater than the riskless rate.

This concludes the information provided by the consultant.

You also have the following information:

- Assume that both expenses and revenues for a year occur at the end of the year. NWC pays the bills during the year, but has to be replenished at the end of the year.
- Android01 is expected to cannibalize the sales of Processor01 while also reducing the variable costs for the production of Processor01. From years 4 to 10, revenues are expected to fall by $5M, whereas variable costs will go down by $1 million. Processor01 is to be phased out at the end of the 10th year.
- At the end of the 15th year, the plant will be scrapped for a salvage value of $10 million. NWC will be recovered.

**Question 10:** Calculate the expected cash flows from the Android01 project based on the information provided.

**Question 11:** Calculate the NPV for a required rate of return of 6.5 percent. Also calculate the IRR and the Payback Period.

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