INTERNATIONAL BUSINESS SCHOOL (IBS) UNIVERSITI TEKNOLOGI MALAYSIA

MASTER OF BUSINESS ADMINISTRATION (MBA) PROGRAMME

SEMESTER 2, 2012/2013

MRC2413 FINANCIAL MANAGEMENT (INDIVIDUAL EXERCISE)

INTEGRATED PROBLEM EXERCISE You are considering three investments. The first is a bond that is selling in the market at $1,200. The bond has a $1,000 par value, pays interest at 14 percent, and is schedule to mature in 12 years. For bonds of risk class, you believe that a 12 percent rate of return should be required. The second investment that you are analyzing is a preferred stock ($100 par value) that sells for $80 and pays an annual dividend of $12. Your required rate of return for this stock is 14 percent. The last investment is a common stock ($25 par value) that recently paid a $3 dividend. The firms earnings per share have increased from $4 to $8 in 10 years, which also reflects the expected growth in dividends per share for the indefinite future. The stock is selling for $25, and you think a reasonable required rate of return for the stock is 20 percent.

1. Calculate the value of each security based on your required rate of return. Value Bond: N I/Y PMT FV CPT based upon required rate of return:

12 12 140 1000 PV

= Preferred Stock:

- 1123.89

Since the dividend is a constant amount each year with no maturity date (infinity), the equation can be as follows:

Common Stock: N PV PMT FV CPT Step 1 :

10 4 0 8 I/Y Determine Growth Rate

Growth Rate (g) = Step 2 :

7.177 % Solve for Value

If the growth rate (g) is assumed constant, the equation should be:

2. Which investment(s) should you accept? Why? Your Value $1,123.89 85.71 25.08 Selling Price $1,200.00 80.00 25.00

Bond Preferred Stock Common Stock

The bond should not be purchased because the selling price is higher than your value. It is better to buy either Preferred Stock or Common Stock because both have selling price below your value.

3. If you required rate of return changed to 14 percent for the bond, 16 percent for the preferred stock, and 18 percent for the common stock, how would your answers to parts 1 and 2 change? N I/Y PMT FV CPT Bond: 12 14 140 1000 PV

Its not advisable to buy the bond because the value is lower than

Preferred Stock:

Not to buy because the value is less than $80.00

Common Stock:

Advisable to buy because the value is higher than $25.00

4. Assuming again that your required rate of return for the common stock is 20 percent, but the anticipated constant growth rate change to 12 percent, how would your answers to questions 1 and 2 change?

Advisable to buy the stock because the stock is now worth more to you ($42) than what you need to pay ($25).