Question

Cerci Manufacturing Corporation (CMC), a publicly-held company, will need $800,000,000 twenty years from now to replace four assembly lines in its fast car manufacturing plants. The management plans to make 20 equal payments, starting today, into the company's brokerage account at the Pepe Investment Fund CMC can buy bonds, which mature in 20 years, or bonds, which mature in 1 year. Both types of bonds currently sell to yield 7 percent, that is the yield to maturity of bonds is 7%. CMC's management best estimate of the future interest rates is that they will stay at current levels, this means the interest rates may fluctuate, but the expected interest rate is the current yield to maturity. There is some risk that the assembly lines will wear out in less than 20 years, in which case CMC will need to cash out its investment on assembly lines before 20 years. If that happens, CMC will desperately need the money that has been accumulated. This money could save CMC from bankruptcy. a) How much should CMC plan to invest each year? b) If CMC decides to invest enough right now to produce the future $800,000,000, how much must it put up? c) What type of bond, do you recommend which might be useful for CMC's purposes? Why? Please be short and specific. d) What type of bond would you recommend CMC actually buy? Why? Please be short and specific.

Answer 1

a) Investment Each Year = 800000000 / 20 = 40000000

b) Present Value = Future Value / (1+ Rate) ^ No of Years

=800000000 / (1+7%) ^ 20

=800000000 / (1.07) ^ 20

=800000000 / 3.8697

=206735202

CMC Should invest $ 206735202 now to produce $ 800000000 in future.

c) CMC should buy bonds with 20years maturity so that CMC should have $ 800000000 at the end of maturity.

d) CMC should buy bonds with 1 years maturity so that CMC should buy assembly before 20Years & does not get cash out & save him from bankruptcy.