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.
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.