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# Calculating payback period and YTM

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1. Assume a \$4,000 investment and the following cash flows for two alternatives.
Year Investment X Investment Y
1 \$1,000 \$1,300
2 800 2,800
3 700 100
4 1,900
5 2,000

a. Under the payback method, which investment should be chosen?
b. Why do other methods allow for a better analysis?

2. A ten-year bond pays 11% interest on a \$1000 face value annually. If it currently sells for \$1,195, what is its approximate yield to maturity?

#### Solution Preview

Please refer attached file for better clarity of tables and formulas.

Solution:

Problem 1
a. Under the payback method, which investment should be chosen?

The payback period is the amount of time required for the firm to recover its initial investment.

Investment X Investment Y
Year Cash flow Cumulative Cash flow Cash flow Cumulative Cash flow
1 \$1,000 \$1,000 \$1,300 \$1,300
2 800 \$1,800 2,800 \$4,100
3 700 \$2,500 ...

#### Solution Summary

There are two problems. Solution to first problem describes the steps to calculate payback period. Solution to second problem depicts the steps to calculate Yield to Maturity (YTM).

\$2.19

## Payback Method, Compute Cash Flow, Compute Price of Bonds

I would like to have these problems worked out in Word format please.

Problem 1) You are called in as a financial analyst to appraise the bonds of the Holtz Corporation. The \$1,000 par value bonds have a quoted annual interest rate of 14 percent, which is paid semiannually. The yield to maturity on the bonds is 12 percent annual interest. There are 15 years to maturity.
a. Compute the price of the bonds based on semiannual analysis.
b. With 12 years to maturity, if yield to maturity goes down substantially to 8 percent, what will be the new price of the bonds?

Problem 2) Assume a \$40,000 investment and the following cash flows for two alternatives.

Year Investment "X" Investment "Y"
1 \$6,000 \$15,000
2 \$8,000 \$20,000
3 \$9,000 \$10,000
4 \$17,000
5 \$20,000
Which of the alternatives would you select under the payback method?