3. What will be the total investment cost for shares? Show appropriate calculations. 4. Which bonds are acceptable for investment? Justify your response with suitable computations
Stephanie Carter has been gifted a sum of $50,000 by her grandparents on completing her
graduation successfully. She is a fresh finance graduate and is excited to invest some money in
the capital market, for which she intends to use the gifted sum of $50,000. However, instead
of committing this money to the market immediately, she decides to wait for some time, work
in the field and acquire some experience before proceeding with her intended investment. She
thus contemplates an extremely conservative investment in a portfolio of stocks and bonds, at
the start of year 5 from now. For now, she will leave the $50,000 in a fixed deposit with the
bank which promises an interest rate of 6% per annum.
She will require a return of at least 9% on her stock investments and 4% on bond investments.
Stephanie would have to pay 25% taxes on any interest income. Dividends will be tax-free.
Stephanie’s research has allowed her to narrow down on the following investment candidates:
Stocks:
1. Pan-Elixir Ltd. is a pharmaceutical company. Its stock is fairly priced. Last year (t = 0),
it paid a dividend of $2.50 per share to its shareholders. The company management has
estimated that it will be able to maintain a constant growth
annum.
2. Rebound Tourism Inc. is a travel planning establishment. Its shares sold for an average
price of $40 per share last year (t = 0) and the management estimates to maintain a
constant growth rate in dividends. Last year, it paid a dividend of $0.50 per share to its
shareholders.
3. Cheers Inc. is a beverage producer. It pays a dividend of $1 per share to its shareholders,
which is likely to remain constant over an indefinite time period.
4. Think-Local Inc. paid $0.75 per share as dividend last year (t = 0). The company
expects that it will take next 2 years (till t = 2) to recover from the pandemic’s effects,
during which time, its dividend will grow at a rate of 1.5% per annum. From year 3
onwards, the dividend growth rate is expected to settle at 2% per year indefinitely.
Bonds:
1. Pleasant Innovations Ltd. had issued a series of 20-year bonds at 98% of face value
(assume face value = $100). These bonds come with a coupon rate of 3% and will be
paid semi-annually. By the start of year 5 from now, 5 years would have passed.
Assume that the YTM remains constant over time.
2. D Right Side Inc. will offer a coupon of 4% per annum on its much awaited 20-year
bonds. By the start of year 5 from now, these bonds would be 2 years old and would
likely sell for a price of $70 per bond (face value = $100). Coupons would be paid
annually. Assume that the YTM will remain constant over time.
3. Tried and tested Ltd. has bond issue with an after-tax YTM of 6%. 5 years from now,
they have 25 years left to mature and offer a coupon rate of 8% paid annually. These
bonds have a face value of $1,000 each.
Stephanie wants her portfolio to be distributed approximately 5-95 between stocks and bonds
such that around 5% (±3%) of her investable funds are allocated to stocks and 95% (±3%) to
bonds. Her investment criteria further specify that:
i. For all stocks priced below $50, 100 shares each of such stocks be purchased and for
stocks priced above $50, 50 shares each should be purchased.
ii. 100 units of each acceptable bonds be purchased.
Questions:
3. What will be the total investment cost for shares? Show appropriate calculations.
computations
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