FinanceProblem's Problem posted here:?
Question:
Assume that you would like to purchase 100 shares of preferred stock that pays an annual dividend of $6 per share. However, you have limited resources now, so you cannot afford the purchase price. In fact, the best that you can do now is to invest your money in a bank account earning a simple interest rate of 6% but where interest is compounded daily (assume a 365-day year). Because the preferred stock is riskier, it has a required annual rate of return of 12%. (Assume that this rate will remain constant over the next 5 years.) For you to be able to purchase this stock at the end of 5 years, how much must you deposit in your bank account today, at t = 0?
a.2985
b.4291.23
c.3138.52
d.3704.18
e.4831.25
Since prefered is paying $6 which is 12% the price of the prefered stock is 6/0.12=$50.
So at the end of 5 years you should have 50x100=$5000.
Now if c is the amount invested now paying 6% simple interest rate. Then,
c x 6/100= a
also, c + 5a = 5000 at the end of 5 years
solving two equations with two unknowns, we get,
c=$4716.98
This is the amount to be invested at 6% now in simple interest to get to buy the 12% prefered stock paying $6 annually. e. seems close.
More Questions & Answers...