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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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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

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%)


Other things to do

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%


Choose your risk premium

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


Some perspective

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


Your homework

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.


Finish up

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.


Comment

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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