Part 1: Value of each security
The present interest value will be calculated as A [1 – (1+r) ^ -n]/ r. In this case, A will be the interest, which will be equivalent to 14% * RM 1000 = RM 140. The value of r will be the interest rate, which is 14% while n is the period of 12 years. Therefore, the present value of this interest is RM 140 * [1-(1.14) ^ -12]/ 0.14 = RM 792.44. The present value of the terminal value will be found out by C (1 + r) ^ -n. In this case, C will be the terminal value. This will be calculated by RM 1000 (1.14) ^ - 12 = RM 207.56. The total value will be [1 – (1+r) ^ -n]/ + C (1 + r) ^ -n. Therefore, this total value will be RM 792.44 + RM 207.56 = 1000
The second investment involves a preferred stock. The value of this preferred stock will be calculated by (dividends/ the required rate of return). Dividends are RM 12. The required rate of return is 14%. Its value will be RM 12/ 0.14 = RM 85.71. The third option is the common stock. This value will be obtained by [year-end value/ (RoR - growth rate)]. The RoR is the required rate of return. To obtain the growth rate, the dividends over the last ten years will be applied. The formula to be used is D10 = D1 (1 + g) ^ n. In this formula, D10 was the dividend in year 10, which was RM 8. D1 will be the dividend in year 1, which was RM 4. Therefore, the growth rate is RM 8 = RM 4 (1 + g) ^ 10. Dividing both sides of the equation by RM 4 will lead to 2 = (1 + g) ^ 10. The cube root of will lead to 1.072 = 1 + g. Therefore, g will be 0.072. This is equivalent to 7.2%. The dividend at year end will be RM 3 (1 + 0.072) = RM 3.22. Therefore, the value of this stock will be RM 3.22/ (0.20 – 0.072) = RM 25.16.Part 2: Investment decision
These three investments will be evaluated based on their theoretical values against their market values. For these three investment options, their market values will be dictated by their prices. For the bond, it has a price of RM 1200. It has a theoretical value of RM 1000. The preferred stock has a price of RM 80. Its theoretical value is RM 85.71. The final investment is the common stock. It has a theoretical value of RM 25.16 while its market price is RM 25.
Works Cited
Bricks, H. "Capital Decisions." The New York Times (2012): 55-63.
Graham, John and Scott Smart. Introduction to Corporate Finance: What Companies Do. Stamford: Cengage Learning, 2011.
