Consider two investments that you can make. You can either buy a share of stock

Question

Consider two investments that you can make. You can either buy a share of stock in a company that will pay a dividend of $ 46 every year into the foreseeable future, or a buy a special type of bond that will start paying the same $ 46 in one year, and thereafter that payment will increase at the rate of 2 %, for a total of 4 payments. Is the interest rate is 5 % (in both cases), which investment is better?

To answer this question, calculate the difference between the present values of each investment. That is, obtain the value that results for the present value of buying the stock minus the present value of buying the bond (that way, if the difference is positive then the stock is better, and viceversa). Enter your answer rounded to one decimal.

Please show the steps on using the financial calculator. Thanks

Explanation / Answer

Present value of investment

present value = dividend or intersest/ interest rate - growth

Present value of stock = 46 / 5% - 0% = $920.0

Present value of Bond = 46 / 5% - 2% = $ 1,533.3

SO the present value of bond is greater than the present value of stock. So bond investment is a better option.

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