Mini Case This Mini Case is available in MyFinancelab have the three following a
ID: 2618814 • Letter: M
Question
Mini Case This Mini Case is available in MyFinancelab have the three following alternatives for investing the money You have finally saved $10,000 and are ready to make your first investment. You A Microsoft bond with a par value of $1,000 that pays 4.2 percent on its par Southwest Bancorp preferred stock paying a dividend of $2.63 and selling for value in interest, sells for $1,115, and matures in 4 years. $26.25 . Emerson Electric common stock selling for $60, with a par value of $5. The stock recently paid a $1.88 dividend, and the firm's earnings per share has increased from $2.27 to $3.78 in the past 5 years. The firm expects to grow at the same rate for the foreseeable future. Your required rates of return for these investments are 3 percent for the bond, 5 per- cent for the preferred stock, and 12 percent for the common stock. Using this infor- mation, answer the following questions. a. Calculate the value of each investment based on your required rate of return b. Which investment would you select? Why? c. Assume Emerson Electric's managers expect earnings to grow at 1 percent above the historical growth rate. How does this assumption affect your answers to parts (a) and (b) d. What required rates of return would make you indifferent to all three options?Explanation / Answer
A B C D E 2 a.value of each investment based on required rate of return 3 MICROSOFT BOND 4 FV (F) 1000 5 i= 4.20% 6 C= 42 7 CURRENT PRICE (P)= 1115 D4*D5 8 N 4 9 REQUIRED ( YTM) 3.00% 10 value should be 1045.28 YTM = (C+ ((F-P)/N ))/ (F+P)/2 11 3%=(42+((1000-P)/4))/(1000+P)/2 12 verdict NO (OVERVALUED) 15+0.015P=292-0.25P 13 0.265P=277 14 southwest bancorp preferred stocks 15 d= 2.63 16 p= 26.25 17 REQUIRED 5.00% 18 value should be 52.6 D15/D17 19 20 verdict YES(UNDERVALUED) 21 22 EMERSON ELECTRIC 23 p= 60 24 FV= 5 25 d= 1.88 26 EPS 1 2.27 27 EPS 5 3.78 28 N 5 29 growth= 10.74% RATE(D28;0;D26;-D27;1) 30 d1= 2.0818576841 D25*(1+(D29)) 31 REQUIRED 12.00% 32 value should be 164.8488066618 D30/(D31-D29) 33 34 verdict YES( UNDERVALUED) 35 36 37 b. best investment to invest 38 southwest bancorp 39 current return = 10.019047619 40 10.02% (D15/D16)*100 41 expected 5% 42 surplus =5.02% (10.02-5)% 43 EMERSON ELECTRIC 44 current return = 14.21% (D30/D23)+D29 45 expected 12% 46 surplus= 2.21% (14.21-12)% 47 should invest in southwest bancorp as we are getting higher % of return compaired to our expectation 48 49 C. growth to increase by 1% 50 EMERSON ELECTRIC 51 growth= 11.74% (10.74+1)% 52 d1= 2.100712 D25*(1+D51) 53 REQUIRED 12.00% 54 value should be 807.9661538462 D52/(D53-D51) 55 56 current return = 15.24% (D52/D23)+D51 57 58 should invest in emerson electric as we WILL BE GETTING VERY HIGH RETURNS IN TERMS OF PRICE APPRECIATION 59 60 D. to be indifferent to every policy following required returns must be expected : i.e. if we expect same % of return that we are already getting from such investments we will be indifferent 61 MICROSOFT BOND 62 FV (F) 1000 63 i= 4.20% 64 C= 42 65 CURRENT PRICE (P)= 1115 66 N 4 67 68 REQUIRED RETURN should be ( YTM) 1.25% 69 YTM = (C+ ((F-P)/N ))/ (F+P)/2 YTM = (42+ ((1000-1115)/4 ))/ (1000+1115)/2 70 YTM = (13.25/ 1057.5) 71 72 southwest bancorp preferred stocks 73 d= 2.63 74 p= 26.25 75 76 REQUIRED RETURN should be 10.019047619 (D73/D74)*100 77 10.02% 78 79 80 EMERSON ELECTRIC 81 p= 60 82 FV= 5 83 d= 1.88 84 EPS 1 2.27 85 EPS 5 3.78 86 N 5 87 growth= 10.74% RATE(D86;0;D84;-D85;1) 88 d1= 2.0818576841 D83*(1+(D87)) 89 REQUIRED RETURN should be 14.21% (D88/D81)+D87 90