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UPS has financial difficulties
Apply the concept of present value to your chosen United Parcel Service (UPS). Suppose UPS is selling a bond that will pay you $100,000 in one year from today. Keep in mind that if UPS has financial difficulties in one year, you might not get your full $100,000. Given that a dollar one year from now is almost always worth less than a dollar today, you most certainly would not pay a full $100,000 for this bond.
If you are highly risk averse or strongly prefer having money today to having money tomorrow, then you would pay significantly less than $100,000 for this bond. Higher inflation or high interest rates would also lead you to pay less for the bond. Also, the greater the chance of bankruptcy of United Parcel Service (UPS) the less you should be willing to pay for the bond.
Given the concepts of the time value of money, answer the following questions in a 3-page paper:
1) How much would you pay for this bond today? Take into consideration your own personal risk preferences, interest rates, inflation, and the probability United Parcel Service (UPS) will not be able to pay you back in one year. Note: You do not need any math equations for this part; just explain how much you would personally pay for a $100,000 bond from this company.
2) Based on your answer to the previous question, what would be your discount rate for this bond? Use the present value formulas from the background materials and show your work.
3) Pick two other companies in the same industry as United Parcel Service (UPS). Pick one that you would pay less for a $100,000 bond than you would for United Parcel Service (UPS)’s bond, and another that you would pay more for a $100,000 bond you would for United Parcel Service (UPS)’s bond. Explain why you would pay more or less for their bonds.
To answer questions 1, 2, and 3, include the following in your report:
• Total debt/equity ratios of all three companies. (Note that the higher the debt, the higher the default risk.)
• Profit margin, return on assets, and return on equity ratios of all three companies. (Remember your bond payment will depend on the profit margin and cash flow of the company.)
• Betas of all three companies. (Note that the higher the beta, the higher the risk; the higher the risk, the higher the discount rate.)
• Explanation on the riskiness of all three companies in brief (e.g., the higher the beta, the higher the risk).
• Current ratio and quick ratio of all three companies.
The above factors/ratios will help you to decide the discount rate that you will use to calculate bond prices. You can find the above information by using the website http://finance.yahoo.com/. For example, you want to use General Electric Company. You will need to key in company code “GE” and then click on “Key Statistics” (http://finance.yahoo.com/q/ks?s=GE). You will be able to find all the ratios and beta of the company.
4) What do you perceive you have learned in this assignment? Which of the following learning outcomes do you feel you have mastered?
• Identify factors that determine present value.
• Understand and discuss the concepts of present and future value.
Note: Proper citations and references are required. You must use the sources below in addition to the sources you find on your own and include all on the references page.
Econedlink.org (2012). The time value of money. Retrieved May 2012 from http://www.econedlink.org/lessons/index.cfm?lesson=EM37
Studyfinance.com (2012). Time value of money: Self paced overview. Retrieved May 2012 from http://www.studyfinance.com/lectures/timevalue/index.mv
Biger, N. (2008). Explanation of present values and net present values. Retrieved May 2012 from https://cdad.trident.edu/Presentation.aspx?course=56&term=92&presentation=150
For the following link make sure to check out the sections on present and future values of annuities as these sections will help you with the Case Assignment:
Getobjects.com (2002). Future value. Retrieved May 2012 from http://www.getobjects.com/Components/Finance/TVM/fv.html
You might also want to read Chapter 8 of the following textbook:
Ramagopal, C. (2008). Financial management. New Age International.
The following videos are useful to understand and learn present value of money:
Khanacademy.org (2012). Introduction to present value: A choice between money now and money later. Retrieved May 2012 from http://www.khanacademy.org/video/introduction-to-present-value?playlist=Finance
Khanacademy.org (2012). Present value 2: More choices as to when you get your money. Retrieved May 2012 from http://www.khanacademy.org/video/present-value-2?playlist=Finance
Khanacademy.org (2012). Present value 3: What happens when we change the discount rate? Retrieved May 2012 from http://www.khanacademy.org/video/present-value-3?playlist=Finance
Khanacademy.org (2012). Present value 4 (and discounted cash flow): Let’s change the discount rates depending on how far out the payments are. Retrieved May 2012 from http://www.khanacademy.org/video/present-value-4–and-discounted-cash-flow?playlist=Finance
Harper, D. (2009). Corporate Bonds: An introduction to credit risk. Retrieved May 2012 from http://www.investopedia.com/articles/03/110503.asp#axzz1toL7PDrX
Assignment Expectations:
• Describe the purpose of the paper and provide a conclusion. An introduction and a conclusion are important because many busy individuals in the business environment may only read the first and the last paragraph. If those paragraphs are not interesting, they never read the body of the paper.
