Question

Jason and Kerri​ Consalvo, both in their​ 50's, have $50,000 to invest and plan to retire in 10 years. They are considering two investments. The first is a utility company common stock that costs ​$50 per share and pays dividends of ​$1.50 per share per year​ (a 3% dividend​ yield). Note that these dividends will be taxed at the same rates that apply to​ long-term capital gains. The Consalvos do not expect the value of this stock to increase. The other investment under consideration is a highly rated corporate bond that currently sells for $1,000 and pays annual interest at a rate of 4.0% or ​$40.00 per $1,000 invested. After 10​ years, these bonds will be repaid at​ par, or $1,000 per $1,000 invested. Assume that the Consalvos keep the income from their investments but do not reinvest it​ (they keep the cash in a​ non-interest-bearing bank​ account). They​ will, however, need to pay income taxes on their investment income. If they buy the​ stock, they will sell it after 10 years. If they buy the​ bonds, in 10 years they will get back the amount they invested. The Consalvos are in the 33% tax bracket.

a. How many shares of the stock can the Consalvos​ buy?

b. How much will they receive after taxes each year in dividend income if they buy the​ stock?

c. What is the total amount they would have from their original ​$50,000 if they purchased the stock and all went as​ planned?

d. How much will they receive after taxes each year in interest if they purchase the​ bonds?

e. What is the total amount they would have from their original ​$50,000 if they purchased the bonds and all went as​ planned?

f. Based only on your calculations and ignoring other risk​ factors, should they buy the stock or the​ bonds?

Answer 1