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Module3AssignmentPart2wk7.docx
Module 3 Assignment: Part 2 Capital Budget Decision Making for an Organization
Report prepared by:
Date: December 18, 2022
Walden University
WMBA 6070: Managerial Finance
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Part 2: Long-Term Working Capital Considerations: Time Value of Money and Bonds
Introduction
Long-term working capital requirements is the lifeblood of a company’s success. It is therefore important for business to critically evaluate its current capital decisions on its sustainability. It is against this backdrop that this paper evaluates the long-term working capital consideration of a mid-sized company that has been listed recently.
Future Value and Present Value
|
Future Value |
|
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Interest Rate |
6.0% |
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# Of Periods |
5 |
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Starting Value |
$ 2,000,000 |
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Future Lump Sum |
$ 2,676,451 |
If our company deposits $ 2,000,000 in an account paying an interest rate of 6 % for 5 years, there will be increase in its long-term working capital since the future value will be $ 676,451 more than the original amount deposited.
|
Present Value |
|
|
Interest Rate |
5.0% |
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|
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# Of Periods |
20 |
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Lump Sum in the Future |
$ 29,000 |
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Present Value |
$10,930 |
The present value of a security that promises $ 29,000 in 20 years is $ 10,930. This value is lower that the future value because of inflation effect which affects the value of money. As such the money to be received in future should be higher than the amount today to compensate the investors for decrease in value of money because of inflation.
Bonds
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Bond Valuation |
||
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Face Value |
$1,000 |
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Yield to Maturity |
8.2% |
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Coupon Bond C |
11.50% |
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Coupon Bond Z |
0% |
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Years to Maturity |
Price of Bond C |
Price of Bond Z |
|
4 |
$1,108.82 |
$729.61 |
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3 |
$1,084.74 |
$789.44 |
|
2 |
$1,058.69 |
$854.17 |
|
1 |
$1,030.50 |
$924.21 |
|
0 |
$1,000.00 |
$1,000.00 |
As part of the long-term working capital our company has options of issuing bonds to finance its operations. Both bonds have same face value but different coupon rates and maturity period. The price of bond C is higher than the price of bond Z because bond C has coupon rate of 11.5% against the zero- coupon bond Z. The price of a bond decreases with a decrease in years of maturity because the risk of default on a bond increase as the maturity date gets closer. As the risk of default increases, the price of the bond decreases in order to compensate for the higher risk. Since the bond's maturity is a measure of the time until it must be redeemed and repaid, a decrease in the bond's maturity implies an increase in the risk of default. Therefore, the price of both bonds Cand Z decreases as the maturity decreases in order to account for the increased risk.
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Basic Input Data |
Bond A |
Bond B |
Bond C |
|
Years to maturity |
12 |
12 |
12 |
|
Coupon rate |
7% |
9% |
11% |
|
Par value |
$1,000 |
$1,000 |
$1,000 |
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Periodic payment |
$70 |
$90 |
$110 |
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Yield to maturity |
9% |
9% |
9% |
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Price |
$856.79 |
$1,000.00 |
$1,143.21 |
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Current Yield |
|||
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Bond A |
Bond B |
Bond C |
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Current yield |
8.17% |
9.00% |
9.62% |
The current yield of a bond is an important metric for determining its potential as an investment. It is the annual amount of income received from the bond as a percentage of its market price. Knowing the current yield of a bond is important for our firm’s long-term working capital considerations because it helps us assess the risk of the investment, as well as the potential return. By knowing the current yield, our company can better evaluate whether or not it is a good investment based on our risk profile and the expected return (Fabozzi & Fabozzi,2021). It also allows us to compare different bonds and decide which one offers the best value. In addition, the current yield can help a firm adjust its working capital strategy accordingly in order to maximize our return on investment. A bond with a low current yield is generally better for our firm's long-term working capital considerations. Low current yields may indicate that the bond has a longer-term maturity, which means that the firm will be able to have access to the funds for a longer period of time. Additionally, a low current yield means that our firm will have a lower interest rate to pay, which will have a positive effect on their long- term working capital. In this regard our firms should issue bond A.
|
Type of the Bond |
Face Value |
Price of the bond |
|
|
Bond A |
$1,000 |
$856.79 |
Discount |
|
Bond B |
$1,000 |
$1,000.00 |
At par |
|
Bond C |
$1,000 |
$1,143.21 |
At a premium |
Conclusion
The time value of money is critical in long-term working capital planning. The information about the future and present value calculation provides insight to our company on the best course of actions (Cho et al.2021). For instance, the result has shown that by depositing $ 2million at 6% for 5 years our company will have over 2.6million after 5 years. Besides the current yield of various bond options has shown that our company should invest in a bond with low current yield since it indicates longer payment period hence long-term access to funds.
References
Cho, T., Grotteria, M., Kremens, L., & Kung, H. (2021). The Present Value of Future Market Power. Available at SSRN.
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3921171
Fabozzi, F. J., & Fabozzi, F. A. (2021). Bond markets, analysis, and strategies. MIT Press.
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