1.Suppose you have outstanding debt with an 8% interest rate that can be repaid anytime, and the interest rate on U.S. Treasuries is only 5%. You plan to repay your debt using any cash that you don’t invest elsewhere. Until your debt is repaid, what cost of capital should you use when evaluating a new risk-free investment opportunity? Why?
2.In the summer of 2008, at Heathrow Airport in London, Bestofthebest (BB), a private company,offered a lottery to win a Ferrari or 90,000 British pounds, equivalent at the time to about $180,000. Both the Ferrari and the money, in 100 pound notes, were on display. If the U.K. interest rate was 5% per year, and the dollar interest rate was 2% per year (EARs), how much did it cost the company in dollars each month to keep the cash on display? That is, what was the opportunity cost of keeping it on display rather than in a bank account? (Ignore taxes.)
3.You firm is considering the purchase of a new office phone system. You can either pay $32,000 now, or $1000 per month for 36 months.
a. Suppose your firm currently borrows at a rate of 6% per year (APR with monthly compounding). Which payment plan is more attractive?
b. Suppose your firm currently borrows at a rate of 18% per year (APR with monthly compounding). Which payment plan would be more attractive in this case?