Mr. Lim has $10,000 to invest for a period of 5 years. He has a choice of either the bonds or stocks of the Oxley Company.

(A) Bond: Oxley’s bond: Face value $1,000, 10% coupon paid annually and 8 years’ life remaining. The bond can be purchased at $1,100 today.

(B) Common Stock: Oxley’s common stock just paid a dividend $0.80. Its dividend will grow at 4% per year perpetually. The stock can be purchased at $8 today.

(a) Calculate the rate of return per annum over the 5-year period for the investment in bonds if the required return for the bonds is 7% and coupons can be invested to give a 7% return.           

(b) Compute the rate of return per annum for the investment in stocks over the 5-year period. The required return for the stock is 12%, while dividends received can be invested to give a return of 7%.