Question

1. Mr. Armstrong and Mr. Spendwell are both investors looking to buy financial assets. Mr. Armstrong prefers assets with the lowest prices while Mr. Spendwell prefers assets on the financial market with higher prices. Each of them currently has GHC 1000 to invest and needs your assistance to know which asset to buy to suit their preference. Do well to assist Mr. Armstrong and Mr. Spendwell to make a decision using the following information below;

1. Asset A is a bond with a coupon rate of 10% and pays semiannual coupons. The par value is GHC 1,000, and the bond has 5 years to maturity. The yield to maturity is 11%.
2. Asset B is a stock whose dividend is expected to increase by 20% in one year and by 15% in two years. After that, dividends will increase at a rate of 5% per year indefinitely. The last dividend was GHC 100 and the required return is 20%.
3. Asset C is an annuity which requires one to deposit GHC 30 at the end of each month for three (3) years earning 12% compounded monthly.

Answer 1

Calculation of Price of each assets

i)Price of Asset A

Annual Coupon=GHC 1000*10%=GHC 100

YTM=11% or 0.11

Maturity value=GHC 1000

Price=100/(1+0.11)^1+100/(1+0.11)^2+100/(1+0.11)^3+100/(1+0.11)^4+(100+1000)/(1+0.11)^5

=GHC 963.04

ii)Price of Asset B

Dividend for year 1(D1)=GHC 100(1+0.20)=GHC 120

Dividend for year 2(D2)=GHC 120(1+0.15)=GHC 138

Dividend for year 3(D3)=GHC 138(1+0.05)=GHC 144.90

Price of Asset B at the end of the year 2 (terminal Value)=D3/(Required Return-Growth rate)

=GHC 144.90/20%-5%

=GHC 966

Price of Asset B Today=GHC 120/(1+0.20)+GHC 138/(1+0.20)^2+GHC 966/(1+0.20)^2

=GHC 866.67

iii)Price of Asset C

Price of Asset C=Annuity*PVAF@1% for 36 year

=GHC 30*30.1075

=GHC 903.23

Conclusion:

For Mr. Armstrong,Asset B is suitable as it has lowest price among the given assets.

For Mr. Spendwell,Asset A is suitable as it has highest price among the given assets.