A corporation is looking to invest $200,000. Their cost of capital is j2 = 8%. They have narrowed the possible investments to the following four choices:

(i) Buy a 10-year bond that pays semi-annual coupons of $8150 and is redeemable for $202,000.

(ii) Buy a perpetuity that pays $16,500 at the end of every year

(iii) Buy an ordinary annuity which provides $1640 at the end of every month for 20 years (iv) Buy an investment that provides a payment of $125,000 at the end of 2-years and another payment of $130,000 at the end of 4 years.

(a) Using the net present value method, determine which investment the company should buy by ranking the investments from best to worst. Show all your work.

(b) For any investment in (a) in which NPV > 0, what is the IRR of that investment? State answer as an effective rate, j1 and be as accurate as you can [In (i) you would use the methods of section 6.6; In (ii) you would be able to solve directly for i ; In (iii) you would use linear interpolation; In (iv) you would use a quadratic]. Which investment is best? Is it the same as in (a)?

Topic may include

Determning the Yield Rate

The Method of Interpolation

The Yield Curve