Rate of Return for Stocks and Bonds

CALCULATION – RATE OF RETURN FOR STOCKS AND BONDS

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Calculation – Rate of Return for Stocks and Bonds

Stock Valuation

1. “A stock has an initial price of $100 per share, paid a dividend of $2.00 per share during the year, and had an ending share price of $125. Compute the percentage total return, capital gains yield, and dividend yield.”

1a) Percentage total return = (Dividends paid + Change in market value) / Initial stock price

Percentage total return = ($2 + ($125-$100))/ $100 = $27 / $100 = 0.27 or 27%

1b) Capital gains yield = (Ending share price – Initial share price)/Initial share price

Capital gains yield = ($125 – $100) / $100 = $25 / $100 = .25 or 25%

1c) Dividend yield = Dividend per share earn during the year / the initial stock price

Dividend yield = $2.00 / $100 = 0.02 or 2%

Total Return

2. “You bought a share of 4 percent preferred stock for $100 last year. The market price for your stock is now $120. What was your total return for last year?”

Total return = (Dividend paid + Change in market value) / Initial stock price

Total return = ((4% x $100) + ($120 – $100)) / $100 = ($4 + $20) / $100 = 0.24 or 24%

CAPM

3. “A stock of a beta of 1.20 the expected market rate of return is 12% and a risk-free rate of 5 percent. What is the expected rate of return of the stock?”

Expected rate of return = Risk-free rate + (Beta x (Expected market rate – Risk-free rate))

Expected rate of return = 5% + (1.20 x (12% – 5%) = 5% + (1.20 x 7%) = 5% + 8.4%

Expected rate of return = 13.4%

WACC

4. “The Corporation has a targeted capital structure of 80% common stock and 20% debt. The cost of equity is 12% and the cost of debt is 7%. The tax rate is 30%. What is the company’s weighted average cost of capital (WACC)?”

WACC = (Weight of Equity x Cost of Equity x (1 – Tax rate)) + (Weight of Debt x Cost of debt)

WACC = (80% x 12% x (1 – 30%)) + (20% x 7%) = (6.72% + 1.4%) = 8.12%

FLOTATION COSTS

5. “Medina Corp. has a debt-equity ratio of .75. The company is considering a new plant that will cost $125 million to build. When the company issues new equity, it incurs a flotation cost of 10 percent. The flotation cost on new debt is 4 percent. What is the initial cost of the plant if the company raises all equity externally?”

% of Debt = 0.75 / (1+0.75) = 42.86%

% of Equity = 100% – % of Debt = 100% – 42.86% = 57.14%

Plant funded through debt: 42.86% x $125 million = $53,575,000

Flotation cost on Debt = $53,575,000 x 4% = $2,143,000

Plant funded through equity: 57.14% x $125 million = $71,425,000

Flotation cost on equity = $71,425,000 x 10% = $7,142,500

Total Flotation cost = $2,143,000 + $7,142,500 = $9,285,5000

Initial Cost = $125,000,000 + $9,285,5000 = $134,285,500