QUESTION 3 (14 marks)

You have finally saved RM15,000 and are ready to make your first investment. You have the two following alternatives to invest that money:

ABC preferred stock is paying a dividend of RM2.00 per share and selling for RM22.00.

XYZ common stock is selling RM28.00. The stock recently paid a RM1.50 dividend and the firms earnings per share has increased from RM1.55 to RM2.44 in the past four years. The firm expects to grow at the same rate for the foreseeable future. Your required rates of return for these investments are 8 percent for the preferred stock, and 18 percent for the common stock. Using this information, answer the following questions.

a. Calculate the value of each investment based on your required rate of return. (6 marks)

b. Which investment would you select? Why? (4 marks)

c. Assume XYZs managers expect an earnings downturn and a resulting decrease in growth by 3 percent. How does this affect your answers to parts (a) and (b)? (4 marks)