Reference no: EM133715821

Case: Corporations not only issue securities; they may also invest corporate funds in securities-and other investment vehicles. Suppose you are the chief financial officer of Twenty-Four Security. Although Twenty-Four will need a large amount of funds in a couple of years to finance an expansion of its security services into the Asian market, for now it just needs to find a good place to "park" its money. Suppose that Twenty-Four has $10 million cash on hand today. Calculate the present discount value of the following options.

Question 1. Jack, Twenty-Four's CEO, will take the $10 million and put it under his mattress at home. Two years from now, he will take the money out and return it to Twenty-Four's corporate offices. Assume that Jack's mattress is quite safe and that the yearly discount rate is 5%.

Question 2. Twenty-Four will invest the $10 million in U.S. government bonds. The bonds will mature in two years. They provide two interest payments of $1 million each at the end of year one and year two, and then a final payment of $10 million at the end of year two. Assume that the relevant discount rate is 5% per year.

Question 3. Twenty-Four will purchase a "perpetuity'' from the U.S. government with the $10 million. The perpetuity will provide $1 million every year indefinitely starting one year from now (but no terminal payment because the investment is perpetual). Assume that the relevant discount rate is 5% per year.

Question 4. Twenty-Four will purchase an "annuity'' from the U.S. government with the $10 million. Annuities pay a specified amount of money every year (starting in one year) for a fixed period of time (there is no terminal payment). Suppose the U.S. government annuity will pay $3 million every year for the next four years. Assume that the relevant discount rate is 5% per year.

Question 5. Twenty-Four will use the $10 million to purchase bonds issued by Crafty Cartoons, a distributor of children's animated programs. The bonds pay no interest in years one and two (they are "zero-coupon" bonds). Instead, the bonds provide a lump sum payoff of $15 million at the end of year three. Would your answer change if the U.S. government guarantees the bonds?