Reference no: EM13786467
GRP Corporation has $500,000 in a bank account paying 0.35% annual interest. As an alternative to leaving the money in the account, the company is considering investing the entire amount for five years. Five possible investments have been identified as shown below.
• Investment A is fifty five-year discount government bonds which cost $10,000 each and will repay all interest and principal ($10,000) in a lump sum at maturity. The current market rate on similar bonds is 2.5%.
• Investment B is five hundred five-year corporate coupon bonds which cost $1,000 each and will pay annual interest with the par value ($1,000) repaid at maturity. The coupon interest rate on the bonds is 4% and the current market rate on bonds of a similar credit rating is 3.5%.
• Investment C is five thousand shares of preferred stock which costs $100 per share and pays a fixed annual dividend of $8.50 per share. The current market rate of return on similar preferred stock is 9%.
• Investment D is ten thousand shares of common stock which costs $50 per share and recently paid an annual dividend of $4.25 per share. The company has been increasing earnings and dividends at an average annual rate of 4%. The current market rate of return on similar common stock is 12%.
• Investment E is a new machine tool center which would be used in an expanded assembly line in the company's manufacturing plant. The tool center will cost $500,000 and is expected to return cash flows of $125,000 per year for five years. The company uses a cost of capital of 10% for this type of investment.
Assuming that you will invest in only one of these five (if any), which would you choose and why? Refer to your calculations and to any other appropriate factors (such as risk) in your answer. Make sure to explain the approach you took in your calculations and why it is appropriate to this problem.
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