Corporate Finance

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Introduction to corporate finance

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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,, e!ual to its par "alue.
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 the example
illustrate regarding a project’s life, its discounted payback period, and its
!"?
a. Payback on this bond is 25 years. You pay $1,000. You receive $40 a year for 25
years, a total of $1,000.
b. The bond is not necessarily a bad investent. Payback does not take tie value
of oney into account, nor does it account for cash flo!s received after the
payback period. "t is ore appropriate to calculate the #P$ of an investent.
%iven the risk level of the bond, is 4& a fair return' "f the ans!er is yes, then
the bond ay be a (ood investent.
c. The discounted payback, usin( a 4& discount rate, is )0 years. This sho!s that
unless the acceptable payback period is decreased !hen discounted payback is
used, vs. re(ular payback, then pro*ects !hich return oney late in the life of
the investent are even ore disadvanta(ed under discounted payback than
under re(ular payback. #P$ is a ore appropriate ethod to use to deterine
the value of an investent pro*ect.
8-#
$or each of the pro%ects sho&s in the follo&in' table, calculate the internal rate of return ()**+.
,ro%ect - ,ro%ect . ,ro%ect / ,ro%ect 0
)nitial /ash
1utflo& (/$+ $22, $44, $18, $213,
4ear (t+ /ash )nflo&s (/$1+
1 $15, $163, $2, $18,
2 2, 163, 2, #,
6 24, 163, 2, 22,
4 28, 163, 2, 34,
3 62, --------- 2, ---------
,ro%ect - ,ro%ect . ,ro%ect / ,ro%ect 0
)nitial /ash $lo& ($22,+ ($44,+ ($18,+ ($213,+
1 $15, $163, $2, $18,
2 $2, $163, $2, $#,
6 $24, $163, $2, $22,
4 $28, $163, $2, $34,
3 $62, $2,
"++ 1,.4& -.,& 2,.2& 21.4&
Please see the attached e.cel sheet
1-1a
)ntel /orp. ()7T/+ has a capital structure consistin' almost entirely of e!uity.
)f the beta of )7T/ stock e!uals 1.5, the risk-free rate e!uals 5 percent, and the e8pected return
on the market portfolio e!uals 11 percent, &hat is )7T/9s cost of e!uity:
/ost of 01uity 2 3& 4 51.3611&73&89
2 14&
1-6
)n its 25 annual report, The /oca-/ola /ompany reported sales of $24.# billion for fiscal
year 25 and $26.1 billion for fiscal year 23. The company also reported operatin' income
(rou'hly e!ui"alent to ;.)T+ of $5.61 billion, and $5.# billion in 23 and 25, respecti"ely.
<ean&hile, arch-ri"al ,epsi/o, )nc. reported sales of $63.14 billion in 25 and $62.35 billion
in 23. ,epsi/o9s operatin' profit &as $5.44 billion in 25 and $3.#2 billion in 23. .ased on
these fi'ures, &hich company had hi'her operatin' le"era'e:
,epsico has a hi'her operatin' le"era'e as per the attached e8cel sheet
/oca-/ola ,epsi
25 23 25 23
Sales $24.# $26.1 $63.14 $62.35
1peratin' income $5.# $5.61 $5.44 $3.#2

01= .81 1.11

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