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As the CFO of IPS, you are responsible for managing the IPS employee pension fund. Like any pension fund, yours has physical and financial assets, and liabilities. You must decide how the pension fund money will be invested. Your decisions will affect the well-being of your firm and its employees. As a successful fund manager, you know that an understanding of the time value of money is key.
You urge your staff to investigate the investment potential of a variety of financial products and services including money markets, real estate, stocks, and insurance products. Your goal is to realize the maximum benefit for your clients.
Since IPS is still a relatively small company, you are also responsible for decisions on product viability and financing. While your staff is investigating pension fund investments, you get the following email message from the CEO.
"Remember the production analysis you did on the Android01? I need you to put together an analysis of the suitability of the project. Crunch the numbers and give me an idea of the value of the project. Thanks for your help!"
You've barely had time to think about what you've read when you get another message from the CEO.
"Meant to ask you about the cost of capital. If we do decide to move forward with the Android01 project, we'll need to determine our best source of capital. As far as I can tell, we have three options:
a loan from the bank
collaboration with another firm
liquidation of securities owned by IPS
Compare the three financing options and estimate NPVs and IRRs from the costs and expected cash flows. Just include that in your analysis. Thanks again!"
This project will require you to determine the suitability of a candidate project using capital budgeting techniques based on time value of money, and taking care to distinguish between different forms of costs and revenues. You will determine the long-term capital requirements needed to support the organization and analyze different methods of financing.
Begin with "Step 1: Time Value of Money Calculations"
As the manager of the pension fund, considering different investment options will help you make better decisions for your company and your clients. Please respond to the following questions, providing supporting data and showing your calculations.
Before starting your calculations, review the following materials:
time value of money analysis
valuing perpetuities and annuities
amortizing a loan
Question 1: If the pension plan invests $95 million today in 10-year US Treasury bonds (riskless investment with guaranteed return) at an interest rate of 3.5 percent a year, how much will it have by the end of year 10?
Question 2: If the pension plan needs to accumulate $14 million in 13 years, how much must it invest today in an asset that pays an annual interest rate of 4 percent?
Question 3: How many years will it take for $197 million to grow to be $554 million if it is invested in an account with a quoted annual interest rate of 5 percent with monthly compounding of interest?
Question 4: The pension plan also invests in physical assets. It is considering the purchase of an office building today with the expectation that the price will rise to $20 million at the end of 10 years. Given the risk of this investment, there should be a yield of 10 percent annually on this investment. The asking price for the lot is $12 million. What is the annual yield (internal rate of return) of the investment if the purchase price is $12 million today and the sale price 10 years later is $20 million? Should the pension plan buy the office building given its required rate of return?
Question 5: The pension plan is also considering investing $70 million of its cash today at a 3.5 percent annual interest for five years with a commercial bank. The bank in return will pay an annuity due at the beginning of year 6 for the next 15 years. How much will the annual payments be from years 6 to 21, if the rate at which these payments are discounted is also 3.5 percent?
Question 6: The pension plan is about to take out a 10-year fixed-rate loan for the purchase of an information management system for its operations. The terms of the loan specify an initial principal balance (the amount borrowed) of $4 million and an APR of 3.75 percent. Payments will be made monthly. What will be the monthly payment? How much of the first payment will be interest, and how much will be principal? Use the Excel PMT function to provide the answers to these questions.
Be sure to show your calculations in Excel and provide a narrative analysis
Step 2: Basic Capital Budget Analysis
As the manager of the pension fund, you are frequently targeted by software companies peddling investment simulation software. You have finally narrowed down your choice to two applications. You need to analyze the options by calculating NPV, IRR and Payback Period based on their purchase price and savings to your company over time. Your staff has prepared a cash-flow table to help you. Year zero shows the purchase price of each application, and the figures listed for years 1-3 represent the savings to the company in successive years.
| Year | Application I | Application II |
| 0 (today) | -$1.5 million | -$1 million |
| 1 | $0.8 million | $0.5 million |
| 2 | $0.7 million | $0.24 million |
| 3 | $0.3 million | $0.6 million |
You are considering three possible scenarios.
Question 7: If the payback period is two years, which application should be selected?
Question 8: If the required rate of return is 15 percent, which application should be selected?
Question 9: If the selection criterion is IRR, which application should be selected?
Respond to the questions 7, 8, and 9 above by submitting a single, integrated report that shows your supporting data and calculations. Finally, provide a recommendation and rationale for purchasing either Application I or Application II.
Be sure to show your calculations in Excel and provide a narrative analysis. Your narrative analysis should include your recommendation and rationale for purchasing either Application I or Application II.
