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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 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.

Essentials Of Investments
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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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 rate in dividends of 3% per 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.
Transcribed Image Text: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 rate in dividends of 3% per 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: 1. Compute the expected intrinsic price of each stock in year 5. Assume that a) All stocks are fairly priced such that the intrinsic and market values are equal. b) Dividends are paid at the beginning of the year 2. How many units of each stock will Stephanie buy? Support your response with relevant computations. 3. What will be the total investment cost for shares? Show appropriate calculations.
Transcribed Image Text: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: 1. Compute the expected intrinsic price of each stock in year 5. Assume that a) All stocks are fairly priced such that the intrinsic and market values are equal. b) Dividends are paid at the beginning of the year 2. How many units of each stock will Stephanie buy? Support your response with relevant computations. 3. What will be the total investment cost for shares? Show appropriate calculations.
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why did you use the dividend yield to calculate the Stock price in 5yrs?  why not use the current stock price *(1+constant growth rate 3%)^5. please asvise

don't the dividend yield decrease when the stock price increases?  

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Follow-up Question

can you show step by step working how you your answer for Share price or intrinsic value of Plan Elixir Ltd stock is $65.50.

what i did was 42.92(1+0.03)^5 = 49.75 please advise

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