March 2021 | MGMT 332 | College of Business | worldwide.erau.edu Aeronautical University, Daytona Beach, Florida, 32114. No part of this material may be reproduced, stored in a retrieval system or transmitted in any form, electronic, mechanical, photocopying, recording or otherwise without the prior written consent of the University. MGMT 332 Corporate Finance I Module 7: Long Term Financing and Leasing Problem Set 7 – Long Term Financing and Leasing 1. In January 1, 2016, Argo issued a 10-year, 0M bond paying 5.55% annually in two equal coupons each June and December. It is now June 2020 and Argo just paid the June coupon on its existing bond.

Rates have come down, so it is thinking of buying back the bond and issuing a 5-year, 0M bond. This bond matures in June 2025 and will pay 3.45% per year in equal coupons each June and December. a. What is the price that Argo must pay the current bond holders to buy back the bond? (Hint - the present value of the coupon payments and the final face value) b. What are the cash flows associated with the new bond? c. What are the cash flow differentials to Argo?

In other words, what are the net cash flows in or out for Argo each June and December when comparing both bonds? d. What is the present value of these cash flow differentials? 2. Argo's real estate department is considering buying an office and leasing it out. They ask you to calculate the NPV (7% discount rate) and IRR of the investment and have given you the data below.

Assume that the office is sold in year 20 and that the mortgage runs 20 years. Item Value Inflator Square Footage 2,000 Property Price ($) 595,000 Down Payment 20% Interest Rate 5.2% Closing Costs at Start ,000 Broker Fee in Year 20 5.0% Yearly Property Appreciation 1.2% Rent/ sq. ft/ Inflator 1.40 1.5% Op. Costs/ year ($)/ Inflator 3,400 1.5% Tax Rate 21.0% Depreciation/ year ($) 2,000 Module 7: Long Term Financing and Leasing Prob. 1 in M$ Amt. Coupon Start June Dec.

June Dec. June Dec. June Dec. June Dec. June Dec.

June Dec. June Dec. June Dec. June Dec. Existing Bonds New Bonds Purch.

Price of Exist.Bonds Text answers here Incremental Cash Flows NPV of Incremental CF in June 2020: Prob. Key Assumptions Square footage Property price ($) Down payment Interest rate Closing costs at start Broker fee in year 20 Property Value Yearly appreciation Mortgage Balance Net Property Value Operating Assumptions Rent/sq.ft. / Inflator Op. costs/yr. ($) / Inflator Tax rate Depreciation/year ($) Cash Flows Rent Income minus: Operating Costs minus: Debt Amortization plus: Interest tax shield plus: Depreciation tax shield minus: Initial Expenses plus: Sale Property in year 20 Total Cash Flows IRR NPV @7% Note: Tax shields are the tax gains from expensing interest or depreciation. The general formula is interest expense x tax rate for interest tax shield.

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Paper for above instructions

Assignment Solution for Long-Term Financing and Leasing: Argo Corporation

This assignment explores the long-term financing and leasing strategies of Argo Corporation. We will compute the cost of buying back an existing bond that Argo currently holds, analyze the cash flows associated with a new bond, assess differential cash flows, and evaluate both the Net Present Value (NPV) and Internal Rate of Return (IRR) for an investment in real estate.

Problem 1:

Part (a): Price of Existing Bonds

To find the price Argo must pay to buy back the current bond, we need to calculate the present value of the future cash flows associated with this bond. The bond pays semiannual coupons and will yield its face value at maturity.
1. Calculate the Semiannual Coupon Payment:
\[
\text{Coupon Payment} = \frac{\text{Face Value} \times \text{Coupon Rate}}{2} = \frac{700M \times 0.0555}{2} = 19.425M
\]
2. Determine the Number of Remaining Payments:
Since it is June 2020 and the bond matures in 2026 (10 years total), there are 6 years remaining of payments:
\[
\text{Remaining Payments} = 6 \times 2 = 12 \text{ payments}
\]
3. Calculate the Present Value of Future Cash Flows:
The discount rate with which to discount future cash flows equals the new bond's coupon rate as rates have come down to 3.45%. But as a conservative approach and for an accurate measure, we might use the market yield rate (current yield of 3.45%).
\[
PV = \sum_{t=1}^{12} \frac{\text{Coupon Payment}}{(1 + \frac{0.0345}{2})^{t}} + \frac{700M}{(1 + \frac{0.0345}{2})^{12}}
\]
Let’s break that down:
\[
PV(\text{Coupons}) = 19.425M \times \left[ \frac{1 - (1 + \frac{0.0345}{2})^{-12}}{\frac{0.0345}{2}} \right]
\]
Using a financial calculator or spreadsheet for the Present Value calculation:
- PV(Coupons) ≈ 2.21M
- PV(Face Value) ≈ 0.97M
Therefore:
\[
\text{Total PV} ≈ 222.21M + 570.97M = 793.18M
\]

Part (b): Cash Flows from the New Bond

1. Semiannual Coupon of New Bond:
\[
\text{Coupon Payment (New)} = \frac{300M \times 0.0345}{2} = 5.175M
\]
2. Total Cash Flows:
The new bond will produce 10 payments (from June 2020 to June 2025). Therefore:
\[
\text{Total Payments} = 5.175M \times 10 + 300M = 300M + 51.75M = 351.75M
\]

Part (c): Cash Flow Differentials

Now we calculate the cash flow differentials between the existing and new bonds on a semiannual basis from June 2020 to June 2025:
1. Existing Bond Cash Flow: .425M
2. New Bond Cash Flow: .175M
The cash flow differential is calculated as follows:
\[
\text{Cash Flow Differential} = 5.175M - 19.425M = -14.25M
\]
This means Argo experiences a cash outflow of \(14.25M\) every six months for this period.

Part (d): Present Value of Cash Flow Differentials

To calculate the present value of these cash flow differentials, we will use the discount rate of 3.45%:
\[
PV(\text{Differential}) = \sum_{t=1}^{10} \frac{-14.25M}{(1 + \frac{0.0345}{2})^{t}}
\]
Calculating the PV over 10 periods yields approximately \(PV \approx -$ 131.1M\).

Problem 2: Real Estate Investment NPV and IRR Calculation

Argo’s real estate department considers purchasing a property to lease it out, and we will calculate the NPV at a 7% discount rate and the IRR.

Initial Investment Calculations

1. Property Purchase Price: 595,000
2. Down Payment: 20% of 595,000 = 119,000
3. Closing Costs: ,000
4. Total Initial Investment: \(119,000 + 4,000 = 123,000\)

Rent Cash Flow Calculation

1. Yearly Rent: \(2,000 \, ft^2 \times 1.4 \, \text{(rent/sq. ft)} \) =

March 2021 Mgmt 332 College Of Business Worldwideeraueduall Ri

March 2021 | MGMT 332 | College of Business | worldwide.erau.edu Aeronautical University, Daytona Beach, Florida, 32114. No part of this material may be reproduced, stored in a retrieval system or transmitted in any form, electronic, mechanical, photocopying, recording or otherwise without the prior written consent of the University. MGMT 332 Corporate Finance I Module 7: Long Term Financing and Leasing Problem Set 7 – Long Term Financing and Leasing 1. In January 1, 2016, Argo issued a 10-year, $700M bond paying 5.55% annually in two equal coupons each June and December. It is now June 2020 and Argo just paid the June coupon on its existing bond.

Rates have come down, so it is thinking of buying back the bond and issuing a 5-year, $300M bond. This bond matures in June 2025 and will pay 3.45% per year in equal coupons each June and December. a. What is the price that Argo must pay the current bond holders to buy back the bond? (Hint - the present value of the coupon payments and the final face value) b. What are the cash flows associated with the new bond? c. What are the cash flow differentials to Argo?

In other words, what are the net cash flows in or out for Argo each June and December when comparing both bonds? d. What is the present value of these cash flow differentials? 2. Argo's real estate department is considering buying an office and leasing it out. They ask you to calculate the NPV (7% discount rate) and IRR of the investment and have given you the data below.

Assume that the office is sold in year 20 and that the mortgage runs 20 years. Item Value Inflator Square Footage 2,000 Property Price ($) 595,000 Down Payment 20% Interest Rate 5.2% Closing Costs at Start $4,000 Broker Fee in Year 20 5.0% Yearly Property Appreciation 1.2% Rent/ sq. ft/ Inflator 1.40 1.5% Op. Costs/ year ($)/ Inflator 3,400 1.5% Tax Rate 21.0% Depreciation/ year ($) 2,000 Module 7: Long Term Financing and Leasing Prob. 1 in M$ Amt. Coupon Start June Dec.

June Dec. June Dec. June Dec. June Dec. June Dec.

June Dec. June Dec. June Dec. June Dec. Existing Bonds New Bonds Purch.

Price of Exist.Bonds Text answers here Incremental Cash Flows NPV of Incremental CF in June 2020: Prob. Key Assumptions Square footage Property price ($) Down payment Interest rate Closing costs at start Broker fee in year 20 Property Value Yearly appreciation Mortgage Balance Net Property Value Operating Assumptions Rent/sq.ft. / Inflator Op. costs/yr. ($) / Inflator Tax rate Depreciation/year ($) Cash Flows Rent Income minus: Operating Costs minus: Debt Amortization plus: Interest tax shield plus: Depreciation tax shield minus: Initial Expenses plus: Sale Property in year 20 Total Cash Flows IRR NPV @7% Note: Tax shields are the tax gains from expensing interest or depreciation. The general formula is interest expense x tax rate for interest tax shield.

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,800 per year
2. Operating Costs: