Question

You are considering three investments to add to your portfolio. The first is a bond that is selling in the market at $1,100. The bond has a $1,000 par value, pays interest at 13 percent, and is scheduled to mature in 15 years. For bonds has a high risk rating (junk bond) and therefore you believe that a 14 percent rate of return should be required. The second investment that you are analysing is a preferred stock ($100 par value) that sells for $90 and pays an annual dividend of $ 13. Your required rate of return for this stock is 15 percent. The last investment is a common stock ($25 par value) that recently paid a $2 dividend. The firm's earnings per share have increased from $3 to $6 in 10 years, which also reflects the expected growth in dividends per share for the indefinite future. The stock is selling for $20, and you think a reasonable required rate of return for the stock is 20 percent.

Calculate the value of each security based on your required rate of return.

Which investment(s) should you accept? Why?

If your anticipated growth rate in dividends per share changed to 12 percent, would your answer change?

Answer 1