Question

You are currently considering three investment possibilities. The first is a bond selling in the market for $1,100. The bond has a $1,000 par value with a coupon of 13 percent and will mature in 15 years. For bonds of this risk class, you believe that a 14 percent rate of return is required. The second investment that you are analyzing is a preferred stock that has a par value of $100, sells for $90 and pays an annual dividend of $13.00. Your required rate of return for this stock is 15 percent. The last investment is a common sto with a par value of $25.00 that recently paid a $2.00 dividend per share. The firm's earnings per share have recorded an annual growth rate of 7 percent and are expected t continue this trend indefinitely. The stock is currently selling for $20.00 and you think that a reasonable required rate of return is 20 percent.

Required: Given the above information,
a. Calculate the intrinsic value of each security.
b. Which investment(s) would you buy? Why?

Intrinsic value of
a. Bond = Pv of coupon payments + PV of maturity face value
= PV(130, 15 years, 14%) + PV (1000, 15 years, 14%)
= $938 This is lower than the current market price of $1100
b. Preferred stock
Intrinsic value = Dividend/Required rate of return
= 13/0.15
= $86.67
c. Common stock
Intrinsic value = Do*(1+g)/(r-g)
=2*(1+0.07)/(0.2-0.07)
= $16.46
Is this correct?

Answer 1

Yes, your calculations for the intrinsic values are correct.

The bond's intrinsic value of $938 is less than the current market price of $1,100, indicating that it may not be a good investment at this time.

The preferred stock