You have finally saved $10,000 and are ready for your first investment.? You hav
ID: 2664204 • Letter: Y
Question
You have finally saved $10,000 and are ready for your first investment.?You have the three following alternatives for investing that money:
A CBS bond with a par value of $1,000, an interest rate of 7.625 percent, and a maturity of 10 years The bond is selling for $986.
Alabama Power Company preferred stock with a $50 par value and a dividend of $2.8125 per 61 year. The stock is currently trading at $39 per share.
Emerson Electric common stock that is selling for $80 with a par value of $5. This stock recently paid a $2.50 dividend, and the firm's earnings per share have increased from $2.40 to $4.48 in the past 5 years. An equivalent amount of growth in the dividend is expected.
Your required rates of return for these investments are 6 percent for the bond, 7 percent for the preferred stock, and 15 percent for the common stock. Using this information, answer the following questions:
a. Calculate the value of each investment based on your required rate of return.
b. Which investment would you select? Why?
c. Assume Emerson Electrics managers expect an earnings downturn and a resulting decreases in growth of 3 percent. How does this affect your answers to parts 1 and 2?
d. What required rates of return would make you indifferent to all three options?
Explanation / Answer
A CBS bond with a par value of $1,000, an interest rate of 7.625 percent, and a maturity of 10 years, the bond is selling for $986.
Par Value of the bond = $1,000
Interest rate (or) Coupon Rate = 7.625%
Number of years to Maturity = 10 years
Current Market value of the bond = $986
Yield to Maturity (YTM) (or) Required Rate of Return = 6%
Calculating Current Market Value of the bond:
Calculating Current Market Value of the bond (PV):
Using Ms-Excel "PV" Function:
Interest Rate (or) Yield to Maturity of the bond (Rate) 6%
Number of Periods to maturity (Nper) 10
Annual Coupon Payment (PMT) [$1,000 * 7.625%] -76.25
Par Value (or) Face Value (or) Future Value of the bond (FV) -1000
Current Market Value of the bond (PV) $1,119.60
Total Investment Amount you have ready to invest = $10,000
Par Value of the bond = $1,000
Number of bonds = [$10,000 / $1,000]
Number of bonds = 10 bonds
Total Value of the Investment = [10 bonds $1,119.60]
Total Value of the Investment = $11,196
Alabama Power Company preferred stock with a $50 par value and a dividend of $2.8125 per 61 year. The stock is currently trading at $39 per share.
Par Value of Preferred Stock = $50 per share
Annual Preferred Dividend = $2.8125 per year
Number of years = 61 years
Current Preferred Stock Value = $39 per share
Cost of Preferred Stock = 7%
Calculating Current Preferred Stock value per share:
Total Investment Amount you have ready to invest = $10,000
Par Value of Preferred Stock = $50 per share
Number of Preferred Shares = [$10,000 / $50 per share]
Number of Preferred Shares = 200 shares
Preferred Stock Value = [D / R]
Preferred Stock value = [$2.8125 / 0.07]
Preferred Stock value = $40.1785
Total Value of Investment = [$40.1785 200 shares]
Total Value of Investment = $8,035.7
Total value of Investment (Bonds) = $11,196
Total value of investment (Preferred stock) = $8,035.70
Among those two investments; investments in the bonds is preferable, because investments in bonds is a better investment compared to investment on preferred stock.
(C) Assume Emerson Electrics Managers expect an earnings downturn and resulting decreases in growth of 3 percent.
Calculating Current Stock Value (P0):
Current Stock Value (P0) = [D1 / (R – g)]
Current Stock Value (P0) = [{$2.50 + ($2.50 * 0.866)} / (0.15 – (-0.03)]
Current Stock Value (P0) = [$4.66 / 0.18]
Current Stock Value (P0) = $25.88
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