newnansm15 - Chapter 15: Selection of a Minimum Attractive...

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Chapter 15: Selection of a Minimum Attractive Rate of Return 15-1 The interest rates on these securities vary greatly over time, making it impossible to predict rates. Three factors that distinguish the securities: Bond Duration Bond Safety Municipal Bond 20 years Safe Corporate Bond 20 years Less Safe The importance of the non-taxable income feature usually makes the municipal bond the one with the lowest interest rate. The corporate bond generally will have the highest interest rate. 15-2 As this is a situation of “neither input nor output fixed,” incremental analysis is required. C- D B- C B- D D- A ∆ Cost $25 $50 $75 $25 ∆ Benefit $4 $6.31 $10.31 $5.96 ∆ Rate of Return 9.6% 4.5% 6.2% 20% Using the incremental rates of return one may determine the preferred alternative at any interest rate. For interest rates between: The problem here concerns Alternative C. C is preferred for 4.5% < Interest Rate < 9.6%. 15-3 Lease : Pay $267 per month for 24 months. Purchase: A = $9,400 (A/P, 1%, 24) = $9,400 (0.0471) = $442.74 Salvage (resale) value = $4,700 (a) Purchase Rather than Lease ∆Monthly payment = $442.71 - $267 = $175.74 ∆Salvage value = $4,700 - $0 = $4,700 ∆ Rate of Return PW of Cost = PW of Benefit 0% 4.5% 9.6% 20% B C D A
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$175.74 (P/A, i%, 24) = $4,700 (P/A, i%, 24) = $4,700/$175.74 = 26.74 i = 0.93% per month Thus, the additional monthly payment of $175.74 would yield an 11.2% rate of return.
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newnansm15 - Chapter 15: Selection of a Minimum Attractive...

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