Question

you are the financial planner for Johnson Controls. Assume last year's profits were$750,000. The Board of Directors decided to forgo dividends to stockholders and retire high interest outstanding balance that were issued for years ago at a face value of $1,410,000. You have been asked to invest the profits in a bank. The board must know how much money you will need from the profit earned to return the bonds in eight years. Bank A pays 8% compounded quarterly, Bank b pays 9% compounded annually

You are the financial planner for Johnson Controls. Assume last year's profits were $750,000. The board of directors decided to forgo dividends to stockholders and retire high-interest outstanding bonds that were issued 4 years ago at a face value of $1,410,000. You have been asked to invest the profits in a bank. The board must know how much money you will need from the profits earned to retire the bonds in 8 years. Bank A pays 8% compounded quarterly, and Bank B pays 9% compounded annually (use Table 1 and Table 2 provided.) (Do not round Intermediate calculations. Round your answers to the nearest dollar amount) a-1. Which bank would you recommend? Bank A O Bank a-2. How much of the company's profit should be placed in the bank? Profit b. If you recommended that the remaining money not be distributed to stockholders but be placed in Bank B, how much would the remaining money be worth in 8 years? Future Value

Answer 1

1)

Bank A pays 6% compounded quarterly, and Bank B pays 7% compounded annually.
Effective Interest Rate for Bank A = (1+(8%/4))^4 – 1 = 8.24%
Effective Interest Rate for Bank B = 9%
Since, EAR for Bank B is higher, it is recommended to put money in Bank B.

2)

Amount to be deposited now to discharge the liability of $1,410,000 in 8 years
= PV of $1,410,000 at 9% (since we have decided to invest at 9%)
= 1,410,000 * PVIF (9%, 8) = 1,410,000 * 0.5019

= $707,679

3)

Hence, $707,679 need to be invested with Bank B at interest rate 9% for 8 years to retire the liability of bonds.
If company deposits $707,679 with the bank then amount at the end of eight years will be $1,410,000
Amount Remaining = $750,000 - $707,679 = $42,321
Value of remaining amount after 8 years if deposited in Bank B
= $42,321 * FVIF (9%, 8) = 42,321 * 1.9926

= $84,328.82