## Question

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

2. Which investment(s) should you accept? Why?

3. If your required rates of return changed to 13 percent for the bond, 16 percent for the preferred stock, and 18 percent for the common stock, how would your answers change to parts (1) and (2)?

4. Assuming again that your required rate of return for the common stock is 20 percent, but the anticipated constant growth rate changes to 5 percent, would your answers to parts (1) and (2) be different?

5. What is the expected rate of return on the three investment alternatives?

Bond Preferred Stock Common Stock

1.Value of the security based on

your required rate of return:

2.Which investment to accept:

3. Changed required rate of return.

New values: 13% 16% 18%

3. Which investment to accept:

Value of common stock if required

rate of return is 20% and growth 5%:

Expected rate of return

## Solution Preview

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Valuation analysisBond Preferred Stock Common Stock

1.Value of the security based on your required rate of return: $1,125.50 $85.71 $27.01

2.Which investment to accept: No Yes Yes

3. Changed required rate of return.

New values: 13%

$1,059.95 16%

$75 18%

$32.42

3. Which investment to accept: No No Yes

Value of common stock if required rate of return is 20% and growth 5%: $21, Not a good investment

Expected rate of return 10.96% 15% 20.97%

The value of the bond has been determined using the PV() function in Excel by discounting the future cash inflows at the rate of 12%. The value of preferred stock has been found using the formula of Annual dividend/Required return....

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