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    Payback methods, IRR, and Right Discount Rate

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    Payback Methods

    8-2 Suppose that a thirty-year U.S. Treasury bond offers a 4 percent coupon rate, paid semiannually. The market price of the bond is $1,000, equal to its par value.

    a. What is the payback period for this bond?
    b. With such a long payback period, is the bond a bad investment?
    c. What is the discounted payback period for the bond, assuming its 4 percent coupon rate is the required return? What general principle does this example illustrate regarding a project's life, its discounted payback period, and its NPV?

    Internal Rate of Return

    8-9 For each of the projects shown in the following table, calculate the internal rate of return (IRR).

    Project A Project B Project C Project D
    Initial Cash
    Outflow (CF) $72,000 $440,000 $18,000 $215,000
    Year (t)
    1 $16,000 $135,000 $7,000 $108,000
    2 $20,000 $135,000 $7,000 $90,000
    3 $24,000 $135,000 $7,000 $72,000
    4 $28,000 $135,000 $7,000 $54,000
    5 $32,000 ? $7,000 ?

    Choosing the Right Discount Rate

    10-1a Intel Corp. (INTC) has a capital structure consisting almost entirely of equality.
    a. If the beta of INTC stock equals 1.6, the risk-free rate equals 6 percent, and the expected return on the market portfolio equals 11 percent, what is INTC's cost of equity?

    10-3 In its 2006 annual report, The Coca-Cola Company reported sales of $24.09 billion for fiscal year 2006 and $23.10 billion for fiscal year 2005. The company also reported operating income (roughly equivalent) to EBIT) of $6.31 billion, and $6.09 billion in 2005 and 2006, respectively. Meanwhile, arch-rival PEPsi Co, Inc. reported sales of $35.14 billion in 2006 and #32.56 billion in 2005. PepsiCo's operating profit was $6.44 billion in 2006 and $5.92 billion in 2005. Based on these figures, which company had higher operating leverage?

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    Payback Methods

    8-2 Suppose that a thirty-year U.S. Treasury bond offers a 4 percent coupon rate, paid semiannually. The market price of the bond is $1,000, equal to its par value.

    a. What is the payback period for this bond?

    Coupon received per year = $1,000 x 4% = $40 per year

    Payback period is defined as the expected number of years required to recover the original investment.

    Payback Period = Initial Amount/Cash flow received each year
    = $1,000/$40
    = 25 years

    b. With such a long payback period, is the bond a bad investment?

    It depends on the objective of the investors. If they are risk-averse and their required rate of return is only 4%, then the bond is not a bad investment. However, if the objective of the investors is to invest in short payback period, then the bond is a bad investment.

    c. What is the discounted payback period for the bond, assuming its 4 percent coupon rate is the required return? What general principle does this example illustrate regarding a project's life, its discounted payback period, and its NPV?

    First you have to find the present value of cash flow year 1 to 30 using 4% and then find the payback period. However, please note that the discounted will be based on semiannual coupon ...

    Solution Summary

    This solution is comprised of a detailed explanation to answer what is the payback period for this bond, is the bond a bad investment with such a long payback period, what is the discounted payback period for the bond, assuming its 4 percent coupon rate is the required return, what general principle does this example illustrate regarding a project's life, its discounted payback period, and its NPV, calculate the internal rate of return (IRR) for each projects, what is INTC's cost of equity, and which company had higher operating leverage.

    $2.19