Session 7 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%.
(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.)
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.