An investment advisor has shown you two investments. Which investment would you

Question

An investment advisor has shown you two investments. Which investment would you recommend and why. Submit using a spreadsheet.

Bond: Coupon bond with a face value of $50,000 that can be purchased today for $48,000 that matures in 5 years. Its annual coupon rate is 9% and the coupon is paid semi-annually.

Stock: Shares of a stock can be purchased for $60 per share today. Its price of a stock is forecast to grow 8% annually for the next 5 years. (your first task is to compute the expected future price). It is expected to pay dividends of $2.00 semi-annually.

Explanation / Answer

Purchase of stock will be recommended in this case as this investment will generate higher annual percentage return than bonds.

However, it should be kept in mind that opportunity cost of capital hasn't been taken into consideration as it is not available. Answer might change if cost of capital was given.

Calculation of returns generated by bond Maturity Value of Bond after five years $   50,000.00 Total Interest during five years (50000*9%*5) $   22,500.00 Less: Purchase Cost of Bond $ (48,000.00) Net Total Benefit from Bond $   24,500.00 Net Annual Benefit from Bond (24500/5) $      4,900.00 Percentage Annual Return (4900 / 48000) 10.21%

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