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?
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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).
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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 ...
Education
- BEng (Hons) , Birla Institute of Technology and Science, India
- MSc (Hons) , Birla Institute of Technology and Science, India
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