Stephanie Carter has been gifted a sum of $50,000 by her grandparents on completing her graduation successfully. She is a fresh finance graduate and is excited to invest some money in the capital market, for which she intends to use the gifted sum of $50,000. However, instead of committing this money to the market immediately, she decides to wait for some time, work in the field and acquire some experience before proceeding with her intended investment. She thus contemplates an extremely conservative investment in a portfolio of stocks and bonds, at the start of year 5 from now. For now, she will leave the $50,000 in a fixed deposit with the bank which promises an interest rate of 6% per annum.

She will require a return of at least 9% on her stock investments and 4% on bond investments. Stephanie would have to pay 25% taxes on any interest income. Dividends will be tax-free. Stephanies research has allowed her to narrow down on the following investment candidates:

Stocks:

1. Pan-Elixir Ltd. is a pharmaceutical company. Its stock is fairly priced. Last year (t = 0), it paid a dividend of $2.50 per share to its shareholders. The company management has estimated that it will be able to maintain a constant growth rate in dividends of 3% per annum.

2. Rebound Tourism Inc. is a travel planning establishment. Its shares sold for an average price of $40 per share last year (t = 0) and the management estimates to maintain a constant growth rate in dividends. Last year, it paid a dividend of $0.50 per share to its shareholders.

3. Cheers Inc. is a beverage producer. It pays a dividend of $1 per share to its shareholders, which is likely to remain constant over an indefinite time period.

4. Think-Local Inc. paid $0.75 per share as dividend last year (t = 0). The company expects that it will take next 2 years (till t = 2) to recover from the pandemics effects, during which time, its dividend will grow at a rate of 1.5% per annum. From year 3 onwards, the dividend growth rate is expected to settle at 2% per year indefinitely.

Bonds:

1. Pleasant Innovations Ltd. had issued a series of 20-year bonds at 98% of face value (assume face value = $100). These bonds come with a coupon rate of 3% and will be paid semi-annually. By the start of year 5 from now, 5 years would have passed. Assume that the YTM remains constant over time.

2. D Right Side Inc. will offer a coupon of 4% per annum on its much awaited 20-year bonds. By the start of year 5 from now, these bonds would be 2 years old and would likely sell for a price of $70 per bond (face value = $100). Coupons would be paid annually. Assume that the YTM will remain constant over time.

3. Tried and tested Ltd. has bond issue with an after-tax YTM of 6%. 5 years from now, they have 25 years left to mature and offer a coupon rate of 8% paid annually. These bonds have a face value of $1,000 each.

Stephanie wants her portfolio to be distributed approximately 5-95 between stocks and bonds such that around 5% (3%) of her investable funds are allocated to stocks and 95% (3%) to bonds. Her investment criteria further specify that:

i. For all stocks priced below $50, 100 shares each of such stocks be purchased and for stocks priced above $50, 50 shares each should be purchased.

ii. 100 units of each acceptable bonds be purchased.

QUESTIONS ARE :: QUESTIONS ARE LISTED BELOW

1. Compute the expected intrinsic price of each stock in year 5. Assume that

a) All stocks are fairly priced such that the intrinsic and market values are equal. b) Dividends are paid at the beginning of the year

(2.5 per stock = 10 marks)

2. How many units of each stock will Stephanie buy? Support your response with relevant computatio ns.

(0.5 + 0.5 + 0.5 + 0.5 = 2 marks)

3. What will be the total investment cost for shares? Show appropriate calculations.

(2 marks)

4. Which bonds are acceptable for investment? Justify your response with suitable computatio ns.

5. What will be the total cost of investment in bonds?

(3 + 3 + 3 = 9 marks)

(0.5 + 0.5 + 2 = 3 marks)

6. Do the stock and bond investments fall within Stephanies investment guidelines? Show appropriate computations in support of your response.

(1 mark)

7. Will Stephanie have enough funds for her investment in stocks and bonds, when needed? What will be the surplus / shortfall, if any?

(2 marks)

8. Given that Stephanies bank offers an interest rate of 6% per year, what additional amount should she have deposited as a fixed deposit in the bank so as to accumulate the amount needed for her investment in stocks and bonds when needed?

(2 marks)

9. Suppose Stephanie deposited the $50,000 in a fixed deposit. For the shortfall, she thought of purchasing a 5-year ordinary annuity that pays an interest rate of 3.5% per annum, what annual deposit will be required to cover the shortfall?

(2 marks)

10. Which of the two options would you recommend for covering the shortfall (Choose between the options in questions 8 and 9 above). Support your response with suitable computatio n.

(2 marks)