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Your Homework

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 rate of return should you look for on one of these bonds?. Things to Do.

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Your Homework

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  1. 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 rate of return should you look for on one of these bonds?

  2. Things to Do • A rate of return is made up of 4 components • List the interest rate you assumed for each of the 4 components • What do you believe the current rate of inflation is? • Use your knowledge from the news, a government web site or your perception • The answer is not right or wrong based on the number you choose • (although a will write a dirty note about your intelligence if you choose 25%)

  3. Other Things to Do • List the traditional safe rate of return (standard rental rate for money) • It is a specific range of numbers • You may select any number in that range • List the one-up-manship (or motivation premium) • Usually about 1/10th of 1%

  4. Choose Your Risk Premium • Risky investments get a higher risk premium than safe investments • You may want to consider • How good is Toyota as a company? • How good is the location in terms of workforce, location etc? • How solid and variable is the market for sports sedans? • Other factors that appear critical in your thinking

  5. Some Perspective • Risk premium on U.S. Treasury Bonds is considered to be about 0% • Risk premium for typical mining venture is around 9% • Typical Mechanical or factory investment is around 6-8% • Civil infrastructure projects are usually around 2-4% • High risk junk bonds may have 30% risk premium

  6. List • Write the risk premium you chose and a brief explanation of why you believe the risk premium to be reasonable • If you find yourself writing more than about 5 sentences you are working yourself too hard and over-analyzing relative to the expectation for this assignment.

  7. Finish Up • Now combine the interest rates to get the rate of return you should expect on the bond • Remember not to make the sucker mistake when you do this (there is a popular sucker mistake out there waiting for you) • List the rate of return you would expect and mark or indicate it on the assignment so it is clearly identifiable.

  8. Comment • I grade on a partial credit basis • There is usually value in working neatly, explaining your steps, and showing how you got an answer • (If you just jump to an answer and it happens to be wrong – what grade can I give you?) • I am usually more concerned about how you did a problem than the number you got in the end (thus a good method will get most of the points even if the answer is messed up)

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