A CBS bond with a par value of $1,000, an interest rate of 7.625 percent, 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 a $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 these investments are 6 percent for the bond, 7 percent for the preferred stock, and 15 percent for the common stock. Using this information, answer the following questions:
Calculate the value of each investment based on your required rate of return.
Which investment would you select and why?
Assume Emerson Electric’s managers expect an earnings downturn and a resulting decrease in growth of 3 percent. How does this affect your answers to part 1 and 2?
What required rates of return would make you indifferent to all three options?
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