Question

Jason and Kerri​ Consalvo, both in their​ 50's, have

​$53,000

to invest and plan to retire in 10 years. They are considering two investments. The first is a utility company common stock that costs

​$53

per share and pays dividends of

​$2.12

per share per year​ (a

4%

dividend​ yield). Note that these dividends will be taxed at the same rates that apply to​ long-term capital gains. The Consalvos do not expect the value of this stock to increase. The other investment under consideration is a highly rated corporate bond that currently sells for

$1,000

and pays annual interest at a rate of

5.0%​,

or

​$50.00

per

$1,000

invested. After 10​ years, these bonds will be repaid at​par, or

$1,000

per

$1,000

invested. Assume that the Consalvos keep the income from their investments but do not reinvest it​ (they keep the cash in a​non-interest-bearing bank​ account). They​ will, however, need to pay income taxes on their investment income. If they buy the​ stock, they will sell it after 10 years. If they buy the​ bonds, in 10 years they will get back the amount they invested. The Consalvos are in the

33%

tax bracket.

a. How many shares of the stock can the Consalvos​ buy?

b. How much will they receive after taxes each year in dividend income if they buy the​ stock?

c. What is the total amount they would have from their original

​$53,000

if they purchased the stock and all went as​ planned?

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

e. What is the total amount they would have from their original

​$53,000

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?

Answer 1

a. They can buy 53,000 / 53 = 1,000 shares of the stock.

b. The stock pays 2.12 per share, so they will receive 2.12 x 1000 = $2,120 per year

Tax rate is 33%, so after tax, they will receive 2,120 x (1 - 0.33) = $1,420.4

c. The total amount they will recieve = 1,420.4 x 10 +53,000= 14,204 + 53,000 = $67,204

d. Number of bonds they can buy = 53,000 / 1,000 = 53 bonds

Interest income per year per bond = 50

Interest income per year = 50 x 53 = $2,650

e. Total amount they will receive = 2,650 x 10 + 53,000 = $79,500

f. They should buy the bonds as they will receive more money with them.