You have finally saved 10,000 and are ready to make your first investment. You have the three following alternatives for investing that money:
1) Captial cities ABC Inc. bonds with a par value of $1000 that pays an 8.75 percent on its par value in interest, sells for $1.34 and matures in 12 years.
2) Southwest Bancorp preferred stock paying a dividend of $2.50 and selling for $25.50.
3) Emerson Electric common stock selling for $36.75 with a par value of $5. The stock recently paid a $1.32 dividend and the firms earning 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 foreseeable future.
Your required rate of return for these investments are 6 percent for the bond, 7 % for the preferred stock, and 15% for the common stock. Using this information answer the folling question.
Calculate the value of each investment based on your required rate of return.
$1134.14
To calculate the value of each investment based on your required rate of return, we need to use the present value formula. The present value (PV) is the current value of a future cash flow, discounted at a specified rate of return.
For the bond investment (alternative 1):
The bond pays an 8.75% interest on its par value of $1000, matures in 12 years, and sells for $1.34.
To calculate the value of this investment, we can use the present value of a bond formula:
PV = (coupon payment / required rate of return) * (1 - 1 / (1 + required rate of return) ^ number of periods) + (par value / (1 + required rate of return) ^ number of periods)
Using the given values:
Coupon payment = 8.75% of $1000 = $87.50
Required rate of return = 6%
Number of periods = 12 years
Plug in the values into the formula to calculate the present value (value of the investment):
PV = ($87.50 / 6%) * (1 - 1 / (1 + 6%) ^ 12) + ($1000 / (1 + 6%) ^ 12)
For the preferred stock investment (alternative 2):
The preferred stock pays a dividend of $2.50 and sells for $25.50.
To calculate the value of this investment, we can use the dividend discount model formula:
PV = dividend / required rate of return
Using the given values:
Dividend = $2.50
Required rate of return = 7%
Plug in the values into the formula to calculate the present value (value of the investment):
PV = $2.50 / 7%
For the common stock investment (alternative 3):
The common stock sells for $36.75 with a par value of $5. It recently paid a $1.32 dividend and the firm's earnings per share have increased. The firm expects to grow at the same rate for the foreseeable future.
To calculate the value of this investment, we can use the constant growth model formula:
PV = (dividend / (required rate of return - growth rate)) + (par value / (1 + required rate of return) ^ number of periods)
Using the given values:
Dividend = $1.32
Required rate of return = 15%
Growth rate = firm's earnings per share growth rate = current EPS / past EPS - 1
Number of periods = not explicitly given
Plug in the values into the formula to calculate the present value (value of the investment):
PV = ($1.32 / (15% - growth rate)) + ($5 / (1 + 15%) ^ n)
Please note that in the common stock calculation, the growth rate and number of periods would need to be determined based on additional information not provided in the question. You may need to gather more details about the firm's expected growth rate to complete the calculation.