Your Homework

• Toyota has decided to build an auto assembly plant in DeSoto for their new Lazer-Razer sports sedan.– Toyota is issuing $1000 dollar bonds to help

pay for the project. The bonds will mature in 5 years.

– What should you pay for one of those bonds today?

Comments on Problem #1

• Look at this problem from your perspective as a bond investor

• Draw the cash flow for this problem as an illustration– You know the exact value of the future cash flow,

but not the present cash flow

– You still know where to put the bar for the present cash flow even if you don’t know the amount

More Problem #1 Comments

• Explain what type of Magic number you will use on what number, why you chose that magic number and what it will do.

• Note that the problem does not tell you what interest rate to use in discounting– Think about the components of an ROR– Explain what your best guess for each component is

and why (real safe companies may have 2% risk premium - real risky 30% or more)

More Problem #1 Components

• Calculate the magic number you will use in this problem– Show exactly how you calculated it– Explain what the magic number will do when

you use it

• Explain why you believe you have the right answer when you finish the problem.

Hint

• This problem will be solved by multiplying one cash flow number by a magic number and that will be the answer.

Homework Problem #2

• Sally Silver Spoon is 10 years old. Her Uncle Ruthless just croked off and left her $50,000 worth of Mutual Funds to pay for her college. Sally estimates that college would cost her $60,000 if she started college now, but Sally won’t actually start college for 8 years. Sally’s financial advisor tells her the cost of college can be expected to go up 5% per year.

Problem #2

• How much will Sally’s College Cost Sally when she starts in 8 years?

• Sally’s Uncle has left her safe and steady tax free Mutual Funds that make 8% per year. Sally wants to save what she needs to pay for college and then spend the rest of the money to buy Barbie dolls, sports cars, and other necessities for 10 year olds.

• How much of the Mutual Fund can Sally liquidate and spend now?

Problem #2 Comments

• As before explain what you are doing with the cash flow and which magic numbers you are using for the manipulation– Explain what each factor is doing

Hint

• This problem can be solved by sweeping the present cost of college ($60,000) 8 years into the future at 5% interest to get the answer to part 1

• To find out how much of the Mutual fund Sally must save take the future pot of dollars from part 1 and sweep it back to right now at 8% interest. This will show how much Sally needs to save.

Problem #3

• Jelly Bean Johnny is buying a new house for $120,000 (which he is borrowing from Pocket Vacuum Bank and Trust). Johnny will take a fixed rate loan at 7.5% interest (annual figure - but compounded monthly) for 30 years. What are Johnny’s monthly mortgage payments going to be? (Principle and interest - leave out taxes and insurance)

Comments

• Draw out the sketch of the cash flow (even though you don’t yet know how much the monthly payments are - you know where they are).

• Explain carefully what you are doing and each step and explain what magic number you will use on what value and what the magic number will do when used.

Hints

• I’m not giving you any on this one.