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MINI-CASE

You have finally saved $10000 and are ready to make your first investment. You have the three following alternatives for investing that money:

Capital Cities ABC Ltd bonds, with a face value of $1000 and a coupon interest rate of 8.75%, are selling for $1314 and mature in 12 years.

Southwest Bancorp preference shares are paying a dividend of $2.50 and selling for $25.50.

Emerson Electric ordinary shares are selling for $36.75. The shares recently paid a $1.32 dividend and the firms earnings per share have increased from $1.49 to $3.06 in the past five years. The firm expects to grow at the same rate for the foreseeable future.

Your required rates of return for these investments are 6% for the bond, 7% for the preference shares and 15% for the ordinary shares. Using this information, answer the following questions.

Questions

1. Calculate the value of each investment based on your required rate of return.

2. Which investment would you select? Why?

3. Assume Emerson Electric's managers expect an earnings downturn and a resulting decrease in growth of 3%. How does this affect your answers to parts (a) and (b)?

4. What required rates of return would make you indifferent to all three options?

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