Your client is considering two investments and has asked you to evaluate these a

Question

Your client is considering two investments and has asked you to evaluate these alternatives. Provide financial and risk advice for your client regarding which to purchase. a 500 shares of a stock that can be purchased for $80 a share. Forecasts are that it can be sold in 5 years for $135 a share. It also is forecasted to pay quarterly dividends of $2.00 per share in the upcoming 5 years. b A bond with a face value of $50,000 that matures in 5 years. It can be purchased for $40,000 today, and it has a coupon rate of 5.00% that is paid semi-annually. Your client is considering two investments and has asked you to evaluate these alternatives. Provide financial and risk advice for your client regarding which to purchase. a 500 shares of a stock that can be purchased for $80 a share. Forecasts are that it can be sold in 5 years for $135 a share. It also is forecasted to pay quarterly dividends of $2.00 per share in the upcoming 5 years. b A bond with a face value of $50,000 that matures in 5 years. It can be purchased for $40,000 today, and it has a coupon rate of 5.00% that is paid semi-annually.

Explanation / Answer

Hi,

Please find the detailed answer as follows:

You need to calculate the rate of return for both the options to arrive at a decision.

Alternative A:

Nper = 5*4 = 20 (indicates the period over which dividend payments are made)

PV = 500*80 = 40000 (indicates the current value of stock)

FV = 500*135 = 67500 (indicates the future/sales value of stock)

PMT = 2 (indicates the amount of quarterly dividend payment)

Rate = ? (indicates the rate of return)

Rate of Return = Rate(Nper,PMT,PV,FV)*4 = Rate(20,2,-40000,67500)*4 = 10.62%

Alternative B:

Nper = 5*2 = 10 (indicates the period over which interest payments are made)

PV = 40000 (indicates the purchase value of bonds)

FV = 50000 (indicates the face value of bond)

PMT = 50000*5%*1/2 = 1250 (indicates the amount of semi-annual interest payment)

Rate = ? (indicates the rate of return)

Rate of Return = Rate(Nper,PMT,PV,FV)*2 = Rate(10,1250,-40000,50000)*2 = 10.21%

Suggestion: Based on the Above Calculations, it is advisable to go for Alternative A as if offers a higher rate of return as compared to Alternative B.

Thanks.

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