WILLIAM. BRUNS Laurinburg Precision Engineering Oliver MacKinnon and Beacham McDougald founded laurinburg Preosion to manufacture precision injection-molded parts for use in medical devices. After an uncertain start- up period, the company won contracts from several different manufacturersUsing special machinery and expertise in injection molding of specialty plawtics tbhe cmpuy grwepiud Foymesring n 1r In early 2004, the company was experiencing a cash crisis caused by capid growth to extend capabilities through the acquisition of new molding machines The pertnens had no additional capital to finance the expansions, and they were reluctant to e bank loan was considered, but financial projections indicated the loan could not be paid down for almost five years. Because of prevailing interest rates, local banks were uwillmake a loan ty to anyone else commitment of that duration. in Charlotte, North Carolina. After a consultation with MacKinnon and Mebougald, Sheila Cox, partner in the investment banking firm, suggested a S1 million bond issue with a term of five years. The bond issue would be secured by the new machinery and placed with private investors. Cox told MacKinnon and McDougald that she expected the bonds would have to be sold to yield almost 10% interest She proposed setting the interest rate on the bonds at 10%, with semiannual interest payments and the principal due at the end of the fifth year, and she prepared a schedule of the interest and principal repayments that would be due if the bonds were sold to yield 10% interest exactly (see Exhibit 1). Although the proposal seemed to be a reasonable solution to the problem facing MacKinnon and McDougald, both were worried about the semiannual interest payments in the early years. They expected operating cash flows would remain tight as Laurinburg Precision Engineering continued to grow. When they expressed this concern to Cox by telephone, she suggested a second alternative. Laurinburg Precision Engineering could issue zero-coupon bonds at the same interest rate and terms. On these bonds no interest payments would be made during the five years the bonds would be outstanding, and all interest and principal would be due on January 15, 2009, when the bonds matured. The principal amount of the zero coupon bonds would be greater than that of the 10% bonds, but Laurinburg would have five years to prepare to pay intenst and principal from either operations or additional financing 098 Laurinburg Precision Engineering estions 1. Using the present-value tables in Exhibits 2 and 3, estimate the number of zero coupon bonds (each with a face value of $1,000) that will have to be offered to provide the $1 million Laurinburg Precision Engineering needs for expansion, if investors seek a yield of 10%. Assume interest will compound on a semiannual basis over the life of the five-year-bond issue. Prepare a schedule similar to Exhibit 1 that shows the interest expense and end-of-period bond liability for each semiannual compounding period. Why is the interest expense for the zero- coupon bonds different from the interest expense on the five-year bonds summarized in Exhibit 1? 2. Assume that MacKinnon and McDougald decide to issue bonds to finance the expansion of Laurinburg Precision Engineering. The terms of the $1,000 bonds to be due January 15, 2009, specify an interest rate of 10% with semiannual compounding or interest payments. However, Sheila Cox is able to find a group of investors who will accept a yield of 8% interest. How much will the investors be willing to pay for the 10% bonds? Prepare a schedule like Exhibit 1 showing principal, interest payments, interest expense, and amortization of bond premium for these bonds. Why does the bond premium amortize to zero? 3. If zero-coupon bonds with semiannual compounding to be due January 15, 2009 are issued, what will be the amount due on that date if enough bonds are issued to provide $1 million on January 15, 2004, if the investors seek a yield of 8%? Prepare a schedule of interest expense and bond liabidities for each semiannual compounding period Exhibit 1 Schedule of Interest Payments, Interest Expense, and Bond Liability for a 10%, Five-year Bond with Semiannual Interest Payments issued to Yield 10% Interest Interest Interest Principal to Date PaymentExpense Carrying Valuebe Pald 1/15/2004 7/15/2004 1/15/2005 7/15/2005 1/15/2006 715/2006 1/15/2007 7/15/2007 1/15/2008 7/15/2008 1/15/2009 $50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 $50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 $1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 $1,000,000 Exhibit 2 Present Value of s1 (I + , 6%-7% Period 3% 4% 5% 8% 10% 97099615 952494349346 9259 9426 9091 873485738264 7938 7513 8885 854882277921762973506830 8626 8219783574737130 68066209 90708900 8638 83068163 9246 9151 8890 8375 7903746270606663 6302 8131 759971076651 6227 5645 58355132 .7894 73076768627458205403 4665 7664 70266446591954395002 4241 10 7441 6756 613558450836323855 Exhibit 3 Present Value of Ordinary Annuity of $1 Period 3% 4% 5% 6% 7% 8% 10% 970996159524 9434934692599091 1913518861 1.8594.83341.8080 1.78337355 2.82862.77512.7232 2.6730 2.6243 2.57712.4869 3.71713.6299 3.54603.4651 3.3872 3.3121 3.1699 4.57974.4518 4.32954.21244.1002 3.99273.7908 5,41725.24215.07574.91734.7665 4.62294.3553 6.23036.00215.78645.58245.38935.20644.8684 7.01976.73276.46326.20985.9713 5.74665.3349 7.78617,43537.1078 6.80176.51526.2489 5.7590 8.53028.1109772177.36017.0236 6.7101 6.1446 10