# Investment Options in Stock Purchasing

Robert Pang, and his wife Jean have 50K to invest. They will need the money at retirement in 10 years. They are considering 2 investments. The first a utility company common stock that costs $50 per share and pays dividends of $2 per share per year (a 4% dividend yield). They did not expect the value of this stock to increase. The other investment under consideration is higly rated corporate bond that currently sells at par in 1,000 increments, and pays annual interest at a rate of 5%, or $50 per 1,000 invested. Assume that the Pangs keep the income from their investments but do not reinvest it. They will however, need to pay income taxes on their investment income. They will set the stock after 10 years if they buy it. If they buy the bonds, in 10 years they will get back in the amount they invested. They are in the 33% tax bracket.

a) How many shares of the stock can the Pangs buy?

b) How much will they receive each year in dividend income if they buy stock, after taxes?

c) What is the total amount they would have from their original 50,000 if they purchased the stock and it all went as planned?

d) How much will they receive each year in interest if they purchase the bonds, after taxes.

e) What is the total amount they would have from their original 50,000 if they purchased the bonds and all went as planned?

f) Based only on your calculations and ignoring other risk factors, should they buy the stock or the bonds.

https://brainmass.com/business/investments-in-securities/investments-options-270459

#### Solution Summary

This solution shows step-by-step calculations in an Excel file to determine number of stock purchase, dividend income, total amount received, and it also provides a recommendation if the Pangs should buy the stock or bonds.

Stock Values and Options

1. The exercise price on a call option is $30 and the price of the underlying stock is $35. The option will expire in 35 days. The option is currently selling for $5.75.

a. Calculate the option's exercise value?

b. Calculate the value of the premium over and above the exercise value? Why is an investor willing to pay more than the exercise value?

c. Is this an out-of-the money, at-the-money, or in-the-money option? Why?

d. What will happen to the value of the option if the underlying stock price changes to $30? Why?

e. Is this an example of a covered call option or a naked call option? Why?

2. The Marcus Company is evaluating the proposed acquisition of a new machine. The machine's base price is $350,000, and it would cost another $125,000 to modify it for special use. The machine falls into the MACRS 3-year class, and it would be sold after 4 years for $40,000. The machine would require an increase in net working capital of $20,000. The machine would have no effect on revenues, but it is expected to save the firm $170,000 per year for 4 years in before-tax operating costs. . The company's marginal tax rate is 30 percent and its cost of capital is 10 percent.

a. Calculate the cash outflow at time zero.

b. Calculate the net operating cash flows for Years 1, 2, 3, and 4

c. Calculate the non-operating terminal year cash flow.

d. Calculate NPV. Should the machinery be purchased? Why or why not?

3. Company Z's stock trades at $45 a share. The company is contemplating a 3-for-2 stock split. Currently, the company has EPS of $3.00, DPS of $0.50, and 20 million shares of stock outstanding. Assuming that the stock split will have no effect on the total market value of its equity, what will be the company's stock price following the stock split?

a. How many shares of stock will be outstanding after the split?

b. Calculate EPS after the split.

c. Calculate DPS after the split. -

d. Calculate price per share after the split -

e. Calculate price after the split if the PE increases by 2 points (for example, if PE was 10 prior to split, it increases to 12 after the split)

f. Why do companies split their stock? Why might a split cause the P/E to increase?

4. Shown below are exchange rates for several currencies.

US$ per 1 euro US$ per 1 franc Mexican peso per US$1

Spot rate 1.38 1.12 12.9

30-day forward rate 1.36 1.13 13.1

60-day forward rate 1.33 1.18 13.9

a. Is the euro appreciating or depreciating against the U.S. dollar? Explain.

b. Is the Swiss franc appreciating or depreciating against the U.S. dollar? Why?

c. Is the Mexican peso appreciating or depreciating against the U.S. dollar? Why?

d. Using cross-rates, based on the spot rate, how many francs will the euro buy, how many pesos will the franc buy, and how many euro will the peso buy?

Euro Swiss Franc Mexican Peso

Spot rate 1.38 1.12 12.90

Cross-rate: euro- buys francs franc buys peso peso buys euro

e. A U.S. company purchases goods from several foreign companies with payment due in euros, francs, and pesos. Would the company be better off paying now or waiting for 60 days? Why?

5. An investment banker enters into a best efforts arrangement to try and sell 10 million shares of stock at $12 per share for Pierre Imports. The investment banker incurs expenses of $2,000,000 in floating the issue and the company incurs expenses of $1,000,000. The investment banker will receive 8 percent of the proceeds of the offering.

a. If the offering is successful and sells out at the expected price of $12, how much money will the company receive?

b. If the offering is successful and sells out at the expected price of $12, how much money will the investment banker receive?

c. If the offering is partially successful; all shares are sold, but at a price of $10. How much does the company receive?

d If the offering is partially successful; all shares are sold, but at a price of $10. How much does the investment banker receive?

e. Who bears more risk with a best efforts deal, the company or the investment banker? Why?

6. Wesley Corporation is evaluating whether to lease or purchase equipment. Its tax rate is 30 percent. If the company purchases the equipment for $1,500,000 it will depreciate it over 5 years, using straight-line depreciation. If the company enters into a 5-year lease, the lease payment is $350,000 per year, payable at the beginning of each year. If the company purchases the equipment it will borrow from its bank at an interest rate of 10 percent.

a. Calculate the cost of purchasing the equipment.

b. Calculate the cost of leasing the equipment with debt.

c. Calculate the net advantage to leasing. Should the company purchase or lease the equipment?

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