Problem:
You have finally saved $10,000 and are ready to make your first investment. You have the three following alternatives for investing that money:
A CBS bond with a par value of $1,000, an interest rate of 7.625, and a maturity of 10 years. The bond is selling for $986
Alabama Power Company preferred stock with a $50 par value and a dividend of $2.8125 per year. The stock is currently trading at $39 per share.
Emerson Electric common stock that is selling for $80 with a par value of $5. This stock recently paid $2.10 dividend, and the firm's earnings per share have increased from $2.40 to $4.48 in the past 5 years. An equivalent amount of growth in the dividend is expected.
Your required rates of return for those investments are 6% for the bond, 7% for the preferred stock, and 15% for the common stock. Using this information, answer the following questions:
Q1. Calculate the value of each investment based on your required rate of return.
Q2. Which investment would you select? Why?
Q3. 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?
Q4. What required rates of return would you indifferent to all three options?