Question

You have finally saved​ $10,000 and are ready to make your first investment. You have the three following alternatives for investing that​ money:

• A Microsoft bond with a par value of ​$1,000 that pays 9.50 percent on its par value in​ interest, sells for ​$1,283.61​, and matures in19 years.

• Southwest Bancorp preferred stock paying a dividend of ​$3.23 and selling for ​$21.56.

• Emerson Electric common stock selling for ​$63.11​, with a par value of​ $5. The stock recently paid a ​$1.16 ​dividend, and the​ firm's earnings per share has increased from ​$2.22 to ​$3.85 in the past 5 years. The firm expects to grow at the same rate for the foreseeable future.

Your required rates of return for these investments are 4.50 percent for the​ bond, 13.50 percent for the preferred​ stock, and 14.00 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​ Electric's managers expect an earnings to grew at

1 percent above the historical growth rate. How does this affect your answers to parts a and​ b?

d. What required rates of return would make you indifferent to all three​ options?

a. If your required rate of return on the bonds is

4.50​%, what is the value of Microsoft​ bond?

Answer 1

Calculation of the value of each investment

(1)Bond data:

FV= Future Value =face value = $1,000

PMT = Coupon = $1,000 * 9.50% = $95

PV = Present Value = price = $1,147.45

nper = mature = 17 years

Typing in Excel the rate function, this equals a return of 7.89%

(2) Preferred stock data:

D = Dividend = $3.14

P = Price = $24.61

Rate return = $3.14 / $24.61 = 0.1276 = 12.76%

Common stock data:

P = Price = $59.27

D = Dividend = $1.49

Growth rate (g) is calculated. For this earnings per share in the last 5 years are considered. The data to take into account are: present value (PV) = $2.37 ; future value (FV) = $3.74 ; nper = 5. With this determine the rate (g=?). This has to ve equal to 9.55%.

With this se calculate the rate return of the common stock.

Rate return = [(Dividend *(1 + g)) / price] + g = [($1.49*(1+0.0955)) / 59.27] + 0.0955 = 0.1231 = 12.31%

Investment give a return above what is required (see table). Anyone can be chosen, however if priority order is considered, Preferred shares would be chosen over common stock and bond.

Calculated Rate	Required Rate
Bond = 7.89%	Bond = 7.50%
Preferred stock = 12.76%	Preferred stock= 10.50%
Common stock = 12.30%	Common stock = 12.00%