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The Wolverine Retirement Fund

Kelly Jones is a financial analyst for Wolverine Manufacturing, a company that produces engine bearings for the automotive industry. Wolverine is in the process of hammering out a new labor agreement with its unionized workforce. One of the major concerns of the labor union is the funding of Wolverines retirement plan for its hourly employees. The union believes the company has not been contributing enough money to this fund to cover the benefits it will need to pay to retiring employees. Because of this, the union wants the company to contribute approximately $1.5 million dollars in additional money to this fund over the next 20 years. These extra contributions would begin with an extra payment of $20,000 at the end of 1 year with annual payments increasing by 12.35% per year for the next 19 years. The union has asked the company to set up a sinking fund to cover the extra annual payments to the retirement fund. The Wolverines CFO and the unions chief negotiator have agreed that AAA-rated bonds recently issued by three different companies may be used to establish this fund. The following table summarizes the provisions of these bonds.

According to this table, Wolverine may buy bonds issued by AC&C for $847.88 per bond. Each AC&C bond will pay the bondholder $80 per year for the next 15 years, plus an extra payment of $1,000 (the par value) in the fifteenth year. Similar interpretations apply to the information for the IBN and MicroHard bonds. A money market fund yielding 5% may be used to hold any coupon payments that are not needed to meet the companys required retirement fund payment in any given year. Wolverines CFO has asked Kelly to determine how much money the company would have to invest and which bonds the company should buy in order to meet the labor unions demands.

1. If you were Kelly, what would you tell the CFO?

2. Suppose the union insists on including one of the following stipulations in the agreement:

a. No more than half of the total number of bonds purchased may be purchased from a single company.

b. At least 10% of the total number of bonds must be purchased from each of the companies. Which stipulation should Wolverine agree to?

Maturity Coupon Payment Company AC&C 15 years S80 IBN $90 10 years $85 Micro Hard 20 years Par Value $847.88 $1,000 $938.55 $1,000 $872.30 $1,000