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
Please help me in this question
To calculate the value of each investment based on the required rate of return, we need to apply the appropriate formula for each investment type.
1) Calculation for Capital Cities ABC Inc. bonds:
The value of a bond can be calculated using the present value formula for bonds. The formula is:
Value of the bond = (Interest * PVIFA) + (Principal * PVIF)
Where:
Interest = Annual interest payment on the bond
PVIFA = Present Value Interest Factor of an Annuity
Principal = Par value of the bond
PVIF = Present Value Interest Factor
In this case, the annual interest payment is 8.75% of $1000, which is $87.50. The required rate of return for the bonds is 6%, so PVIFA can be calculated using the formula for the required rate of return and the bond maturity period of 12 years. PVIFA is found using a financial table or by using financial calculators or software.
Next, we calculate PVIF using the required rate of return and the bond maturity period. PVIF for the given required rate of return and bond maturity can also be found using financial tables, calculators, or software.
Once we have both PVIFA and PVIF, we can substitute these values into the bond value formula to calculate the value of the investment.
2) Calculation for Southwest Bancorp preferred stock:
The value of preferred stock can be found by dividing the annual dividend by the required rate of return. The formula is:
Value of preferred stock = Dividend / Required Rate of Return
In this case, the annual dividend is $2.50, and the required rate of return for the preferred stock is 7%. By substituting these values into the formula, we can calculate the value of the preferred stock investment.
3) Calculation for Emerson Electric common stock:
The value of common stock can be calculated using the dividend discount model (DDM). The formula is:
Value of common stock = Dividend / (Required Rate of Return - Growth Rate)
In this case, the annual dividend is $1.32, and the required rate of return for the common stock is 15%. The firm expects to grow at the same rate for the foreseeable future, so the growth rate is also 15%. By substituting these values into the formula, we can calculate the value of the common stock investment.
By applying the respective formulas, you can calculate the value of each investment based on your required rate of return.