Evaluating Alternative Investments Ellen Hays received a windfall from one of he

Question

Evaluating Alternative Investments
Ellen Hays received a windfall from one of her investments. She would like to invest $100,000 of the money in Linwood Inc., which is offering common stock, preferred stock, and bonds on the open market. The common stock has paid $8 per share in dividends for the past three years, and the company expects to be able to perform as well in the current year. The current market price of the common stock is $100 per share. The preferred stock has an 8% dividend rate, cumulative and nonparticipating. The bonds are selling at par with an 8% stated rate.
1. What are the advantages and disadvantages of each type of investment?
2. Recommend one type of investment over the others to Ellen and justify your reason.

Explanation / Answer

1) Common stock Advantage- as it is giving annual income the present value of overall income will be more than preferred stock.ellen will have participation in voting rights in company. Disadvantage- as it is giving dividend income there are chances of non declaration of dividends Preferred stock- Advantage- the income is defined and company has to pay 8% of face value.so risk is less Disadvantage- ellen will not be able to redeem the money before 3 years. And ellen will not have any voting right in company as the shares are non participating. 2) So i would recommend common stock over preferred stock according to above reasons.As present value of cash income to the investors is more in case of common stock as both the stock are having 8% rate of annual return.

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