You have finally saved $10,000 and are ready to make your first investment. You have the three following alternatives for investing that money:
1. A CBS bond with a par value of $,1000, an interest rate of 7.625 percent, and a maturity of 10 years. The bond is selling for $986.
2. 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.
3. Emerson Electric common stock that is selling for $80 with a par value of $5. This stock recently paid a $2.50 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.
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 an earnings downturn and a resulting decrease in growth of 3 percent. How does this affect your answers to parts 1 and 2?
d. What required rates of return would make you indifferent to all three options?