Chapter 6: Question 17BE (page 304)
Consider the loan in BE6-16. What payments must Zach Taylor make to settle the loan at the same interest rate but with the 6 payments beginning on the day the loan is signed?
The annual loan payment will be $4259.12
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Question:The following are a number of values taken from compound interest tables involving the same number of periods and the same rate of interest. Indicate what each of these four values represents. (a) 6.71008. (c) .46319. (b) 2.15892. (d) 14.48656.
Craig Brokaw, newly appointed controller of STL, is considering ways to reduce his company’s expenditures on annual pension costs. One way to do this is to switch STL’s pension fund assets from First Security to NET Life. STL is a very well-respected computer manufacturer that recently has experienced a sharp decline in its financial performance for the first time in its 25-year history. Despite financial problems, STL still is committed to providing its employees with good pension and postretirement health benefits.
Under its present plan with First Security, STL is obligated to pay \(43 million to meet the expected value of future pension benefits that are payable to employees as an annuity upon their retirement from the company. On the other hand, NET Life requires STL to pay only \)35 million for identical future pension benefits. First Security is one of the oldest and most reputable insurance companies in North America. NET Life has a much weaker reputation in the insurance industry. In pondering the significant difference in annual pension costs, Brokaw asks himself, “Is this too good to be true?”
Instructions
Answer the following questions.
(a) Why might NET Life’s pension cost requirement be $8 million less than First Security’s requirement for the same future value?
(b) What ethical issues should Craig Brokaw consider before switching STL’s pension fund assets?
(c) Who are the stakeholders that could be affected by Brokaw’s decision?
Using the appropriate interest table, compute the present values of the following periodic amounts due at the end of the designated periods. (a) \(30,000 receivable at the end of each period for 8 periods compounded at 12%. (b) \)30,000 payments to be made at the end of each period for 16 periods at 9%. (c) $30,000 payable at the end of the seventh, eighth, ninth, and tenth periods at 12%
Answer each of these unrelated questions.
(a) On January 1, 2017, Fishbone Corporation sold a building that cost \(250,000 and that had accumulated depreciation of \)100,000 on the date of sale. Fishbone received as consideration a \(240,000 non-interest-bearing note due on January 1, 2020. There was no established exchange price for the building, and the note had no ready market. The prevailing rate of interest for a note of this type on January 1, 2017, was 9%. At what amount should the gain from the sale of the building be reported?
(b) On January 1, 2017, Fishbone Corporation purchased 300 of the \)1,000 face value, 9%, 10-year bonds of Walters Inc. The bonds mature on January 1, 2027, and pay interest annually beginning January 1, 2018. Fishbone purchased the bonds to yield 11%. How much did Fishbone pay for the bonds?
(c) Fishbone Corporation bought a new machine and agreed to pay for it in equal annual installments of \(4,000 at the end of each of the next 10 years. Assuming that a prevailing interest rate of 8% applies to this contract, how much should Fishbone record as the cost of the machine?
(d) Fishbone Corporation purchased a special tractor on December 31, 2017. The purchase agreement stipulated that Fishbone should pay \)20,000 at the time of purchase and \(5,000 at the end of each of the next 8 years. The tractor should be recorded on December 31, 2017, at what amount, assuming an appropriate interest rate of 12%?
(e) Fishbone Corporation wants to withdraw \)120,000 (including principal) from an investment fund at the end of each year for 9 years. What should be the required initial investment at the beginning of the first year if the fund earns 11%?
Assume that Wal-Mart Stores, Inc. has decided to surface and maintain for 10 years a vacant lot next to one of its stores to serve as a parking lot for customers. Management is considering the following bids involving two different qualities of surfacing for a parking area of 12,000 square yards.
Bid A: A surface that costs \(5.75 per square yard to install. This surface will have to be replaced at the end of 5 years. The annual maintenance cost on this surface is estimated at 25 cents per square yard for each year except the last year of its service. The replacement surface will be similar to the initial surface.
Bid B: A surface that costs \)10.50 per square yard to install. This surface has a probable useful life of 10 years and will require annual maintenance in each year except the last year, at an estimated cost of 9 cents per square yard.
Instructions Prepare computations showing which bid should be accepted by Wal-Mart. You may assume that the cost of capital is 9%, that the annual maintenance expenditures are incurred at the end of each year, and that prices are not expected to change during the next 10 years.
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