Stock Valuation Mini-Case You have finally saved $10,000 and are ready to make y
ID: 2792740 • Letter: S
Question
Stock Valuation Mini-Case You have finally saved $10,000 and are ready to make your first esment. You have the three following al Your required rates of return for these investments are ternatives for invest 6 percent for the bond, 7 percent for the preferred stock, and 15 percent for the common stock. Using this information, an- ing that money: Capital Cities ABC, Inc. bonds with a par value of $1,000 swer the following questions. and a coupon interest rate of 8.75 percent, are selling for a. Calculate the value of each investment based on your re- S1,314 and mature in 12 years. quired rate of return. Southwest Bancorp preferred stock is paying a dividend of b. Which investment would you select? Why? S2.50 and selling for $25.50. c. Assume Emerson Electric's managers expect an earnings Emerson Electric common stock is selling for $36.75. The downturn and a resulting decrease in growth of 3 percent. How does this affect your answers to parts a and b? stock recently paid a $1.32 dividend and the firm's earnings per share has increased from $1.49 to $3.06 in the past five years. The firm expects to grow at the same rate for the d. What required rates of return would make you indifferent to all three options? foreseeable futureExplanation / Answer
Answer to (a)
Current Yield of Bond of Capital Cities ABC Inc = Coupon Rate/Current Bond Price = 87.5/1314 = 0.0659 = 6.59%
Yield to Maturity = 5.17%
Return from Preference stock = 2.5/25.5 = 0.098 = 9.8%
Return from Common Stock = 1.32/36.75 = 0.00359 = 3.59%
Answer to (b)
Based on above return pattern and required rate of return expectation, the best investment would be on preferred stock.
The bond has CY 6.59% but YTM is 5.17% lower than the expected return by investor. Therefore, it will not meet the expected return criteria of a bond of 6%.
The common stock return is also lower than expected 15% return, though the EPS has gone at good pace but that doesn't guarantee future return from common stock as macro and microeconomic factors are involved in performance of common stock.
Answer to (c)
Due to low growth forecast the company will not perform as predicted earlier leading to downfall of stock price. Therefore, investor should avoid in investing in common stock of Emerson Electric. The best option still would be investing on preferred stock as suggested in section (b).
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.