You have finally saved $10,000 and are ready to make your first investment. You have the three following alternatives for investing that money:
• Bank of Canada bonds with a par value of $1,000, that pays a 6.35% on its par value in interest, sells for $1,020, and matures in 5 years.
• Southwest Bancorp preferred stock paying a dividend of $2.63 and selling for $26.25.
• Emerson Electric common stock selling for $52, with a par value of $5. The stock recently paid a $1.60 dividend and the firm’s earnings per share has increased from $2.23 to $3.30 in the past 5 years. The firm expect to grow at the same rate for the foreseeable future.
Your required rates of return for these investments are 5% for the bond, 8% for the preferred stock, and 12% for the common stock.
Using the information above, answer the following questions:
1. Calculate the value of each investment based on your required rate of return.
2. Select an investment you would prefer explaining why.
3. Assume Emerson Electric’s managers expect the earnings to grow at 1% above the historical growth. How does this affect your answers in (1) and (2)?
4. Explain the potential risk(s) you are exposed to for each of the three alternatives.