You have finally saved $10,000 and are ready to make your first investment. You have the following three alternatives for investing that money:
???? Capital Cities ABC, Inc., bonds, which have a par value of $1,000 and coupon interest rate of 8.75%, are selling for $1,314 and mature in 12 years.
???? Southwest Bancorp preferred stock is paying dividend of $2.50 and selling for $25.50.
???? Emerson Electric common stock is selling for $36.75. The stock recently paid a $1.32 dividend, and the firm’s earning per share have 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 rates of return for these investments are 6% for bonds, 7% for the preferred stock, and 20% for the common stock.
Required:
Calculate the value of each investment based on your required rate of return.
Which investment would you select? Why?
Assume Emerson electric’s managers expect an earnings downturn and a resulting
decrease in growth of 3%. How does this affect your answers to parts 1 and 2?
What required rates of return would make you indifferent to all three options.
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