ASSIGNMENT

Session 7 Questions

Assignment Questions

#1- You are planning to buy 100 shares preferred stock, either Stock A or Stock B. Stock A pays an annual dividend of $4.50 and has a market price of $35. Stock B pays an annual dividend of $4.25 and has a market price of $36. If your required rate of return is 12%, which stock should you buy? HINT: Calculate the appropriate metric and decide.

I would choose stock A as it has a lower selling price of $35.00, pays a higher dividend or $4.50 and the required rate of return is this same.

#2- You intend to buy Marigo common stock at $100 per share, hold it for one year, and sell it after receiving a cash dividend of $6. How much will the stock price have to appreciate for you to achieve a required rate of return of 11%?

D1 = 6, P0=100 (50), Ks = 11% (15%)

SO we have P0 = D1/(Ks-g)

or g = Ks – D1/P0 = 11% – 6/100 = 5%

So P1 = D1*(1+g)/(Ks-g) = 6*(1+5%)/(11%-5%) = $105.00

So Stock price should be $105.00 for giving a 11% return.

#3- You are considering three investments.

- The first is a bond selling for $1,100: it has $1,000 par value, coupon rate of 13%, and 15-year maturity. For bonds in this risk class, it should offer 14% yield to maturity (rate of return).
- The second is a preferred stock with $100 par value selling for $90 per share, with a $13 annual cash dividend – you require a 15% rate of return on this preferred stock.
- The third is a common stock with $25 par value that pays a cash dividend of $2; earnings per share for the company increased from $3 to $6 over 10 years, and the growth in dividends will be the same as the growth in earnings per share. The market price of the stock is $20 per share, and you think a reasonable rate of return on it is 20%.

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*(You are NOT expected to do Excel calculations on this assignment. Therefore, the Excel results are shown below. Explain the inputs, output, and the interpretation of the output.) *

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Using the panel of Excel data on the next page and the Stocks Support Template 2015.xlsx that shows the formulas in the cells, answer these questions:

- Explain how the value of each security is calculated, based on the stated required rate of return.
- Which investment would you buy? Explain.
- If your required rate of return changed to 12% for the bond, 14% for the preferred stock, and 18% for the common stock, how would your answers to parts a and b change? HINT: Don’t do the calculations – explain how the change in required rate of return will change the results.
- Repeat part c with required rates of return of 20% on the common stock, with anticipated constant growth rate changes to 12%.

#4- Which is better, a $40 stock or a $4 stock? Explain very briefly.

#5- Show the equation/formula you would use to calculate the average annual rate of return on a stock you bought on January 27, 2002 for $100 and sold on January 27, 2012 for $150? Assume that dividend payout was zero.

#6- Construct a table to succinctly compare and contrast the building blocks of stock and bond valuation.