Noi Piana Corporation needs $168,000,000 twenty years from now to replace three assembly lines in their Torino plants. Noi Piana Corporation plans to make equal payments, starting today, into an investment account. It can buy bonds, which mature in twenty years, or bonds, which mature in one year. Both types of bonds currently sell to yield 10 percent. Noi Piana Corporation’s best estimate of the future interest rates is that they will stay at current levels, they may go up or they may go down, but the expected interest rate is the current interest rate.
There is some chance that the assembly lines will wear out in less than twenty years, in which case Noi Piana Corporation will need to cash out its investment before twenty years. If that occurs, Noi Piana Corporation will desperately need the money that has been accumulated—this money could save the corporation for bankruptcy and going out of business.
a) How much should Noi Piana Corporation plan to invest each year in the investment account to accumulate enough money to replace the assembly lines?
b) If Noi Piana Corporation decides to invest enough money right now to accumulate the needed $168,000,000 at the end of twenty year, how much must it invest?
c) What type of risk is generally relevant to 1-year bonds and what time risk is generally relevant to twenty-year bonds?
d) Can you suggest any type of bond, which might be beneficial for Noi Piana Corporation’s purposes? Defend your position.