Daphne has recently won a small local lottery and has decided to invest a portion of her winnings. She has hired your services as a financial advisor. You have done some preliminary research on two potential investments to make a report for Daphne. The first investment option you plan to present to Daphne is shares in Nervosa Cafes. Based on your research, this is a relatively young company but is expected to expand quickly over the coming years. You predict the first dividend of $6 will be paid in exactly four years from today. You also predict the annual dividend will grow at 15% per year for 3 years, but then remain level after that. The current market price for one such share is $80. 

a) Draw a cash flow diagram representing the purchase of a single share in Nervosa Cafes. (2 marks) 

b) Write down an equation that could be solved (by computer) to determine the yield, expressed as an effective annual rate, for purchasing a share in Nervosa Cafes. (2 marks) 

c) After conducting a risk analysis on this share, you determine that Daphne should get a return of at least 12% p.a. effective on this share. Based on this conclusion, calculate the maximum price Daphne should pay for this share. (1 mark)

The second investment you plan to present to Daphne is a corporate bond issued by KACL industries. These are $1,000 25-year semi-annual bonds with a coupon rate of 7.40%. 

d) Daphne is aware you plan to present the shares in Nirvosa Cafes and the KACL corporate bonds her investment options. She asked you about the difference between shares and bonds. List 3 differences between shares and bonds (that you could use in the introduction for your report to Daphne). (2 marks) 

e) Draw a cash flow diagram to represent the purchase of a KACL bond

Answer rating: 100% (QA)

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