You recently joined a small investment company in Sydney as an
intern. As part of your first assignment youâ€™ve been given an
opportunity to invest $10,000 of a not so sophisticated investor to
the following alternatives:
â€¢ Capital Fashion Ltd bonds (apparel retailers), with a face value of $1,000 and a coupon interest rate of 8.75% are selling for $1,314 and mature in 12 years.
â€¢Agri Credit Ltd (financial services provider) preference shares are paying a dividend of $2.50 and selling for $25.50
â€¢ Southern Cross Electrical Ltd (electrical appliances manufacturer) ordinary shares are selling for $36.75. The shares recently paid a $1.32 dividend and the companyâ€™s earnings per share have increased from $1.49 to $3.06 in the past five years. The firm expects to grow at the same rate for the foreseeable future.
Your clientâ€™s required rates of return for these investments are 6% for the bond, 7% for preference shares and 15% for the ordinary shares. Using the above information, answer the following questions:
1. Calculate the value of each investment based on the required rate of return. (6 marks).
2. Which investment would you recommend and why? Research on the current trends and future prospects on each of the industries and include a summary. (4 marks).
3. Assume Southern Cross Electricalsâ€™ Chief Finance Officer expects an earning downturn and a resulting decrease in growth of 3%. How does this affect your recommendation? (5 marks).
4. What required rates of return would make your recommendation indifferent to all three options? (5 marks).
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