Jason Consalvo, a 53-year-old software engineer, and his wife, Kerri, have $50,0
ID: 2742770 • Letter: J
Question
Jason Consalvo, a 53-year-old software engineer, and his wife, Kerri, have $50,000 to invest. They will need the money at retirement in 10 years. They are considering two invest-ents. The first is a utility company common stock that costs $50 per share and pays dividends of $2 per share per year (a 4% dividend yield). Note that these dividends will be taxed at the same rates that apply to long-term capital gains. The Consalvos do not expect the value of this stock to increase. The other investment under consideration is a highly rated corporate bond that currently sells for $1,000 and pays annual interest at a rate of 5%, or $50 per $1,000 invested. After 10 years, these bonds will be repaid at par, or $1,000 per $1,000 invested. Assume that the Consalvos keep the income from their investments but do not reinvest it (they keep the cash in a non-interest-bearing bank account). They will, however, need to pay income taxes on their investment income. They will sell the stock after 10 years if they buy it. If they buy the bonds, in 10 years they will get back the amount they invested. The Consalvos are in the 33% tax bracket.
a. How many shares of the stock can the Consalvos buy?
b. How much will they receive after taxes each year in dividend income if they buy the stock?
c. What is the total amount they would have from their original $50,000 if they purchased the stock and all went as planned?
d. How much will they receive after taxes each year in interest if they purchase the bonds?
e. What is the total amount they would have from their original $50,000 if they purchased the bonds and all went as planned?
f. Based only on your calculations and ignoring other risk factors, should they buy the stock or the bonds?
Explanation / Answer
Total Amount for Investment = $50,000
a.
Price of stock = $50
Total number of shares they can purchase from total amount is calculated below:
Number of share purchase = $50,000 / $50
= 1,000
So, Total number of shares they can purchase from total amount is 1,000 Shares.
b.
Dividend Receive per share = $2
Number of share = 1,000
Tax rate = 33%
Amount Receive after taxes each year in dividend income if they buy the stock is calculated below:
After tax dividend receive = (1,000 × $2) × (1 – 33%)
= $2,000 × 67%
= $1,340
So, Amount Receive after taxes each year in dividend income if they buy the stock is $1,340.
c.
Stock price does increase during the period of investment and he does not reinvest the dividend income. So total value of investment after 10 year is calculated below:
Total value = (1,000 × $50) + ($1,340 ×10)
= $50,000 + $13,400
= $63,400
Total value of investment after 10 year if they invest in stock will be $63,400.
d.
Price of bond = $1,000
Total number of bond they can purchase from total amount is calculated below:
Number of bond purchase = $50,000 / $1,000
= 50
So, Total number of bond they can purchase from total amount is 50 bond.
b.
Interest Receive per bond = $50
Number of bond = 50
Tax rate = 33%
Amount Receive after taxes each year in interest income if they buy the bond is calculated below:
After tax interest receive = (50 × $50) × (1 – 33%)
= $2,500 × 67%
= $1,675
So, Amount Receive after taxes each year in interest income if they buy the bond is $1,675.
c.
After 10 year the bond is mature at par value that is at $1,000. So total value of investment after 10 year is calculated below:
Total value = ($1,000 × 50) + ($1,675×10)
= $50,000 + $16,750
= $66,750
Total value of investment after 10 year if they invest in bond will be $66,750.
Since total value of investment after 10 year is higher if they invest in bond than invest in stock. So they should invest in bond instead of stock.
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