Rate of Return for Stocks and Bonds
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ExampleAssignmentfrompreviewsclass.docxWeek4
Purpose of Assignment
The purpose of this assignment is to allow the student an opportunity to calculate the rate of return of equity and debt instruments. It allows the student to understand the effects of dividends; capital gains; inflation rates; and how the nominal rate of return affects valuation and pricing. The assignment also allows the student to apply concepts related to CAPM, WACC, and Flotation Costs to understand the influence of debt and equity on the company's capital structure.
Assignment Steps
Resources: Corporate Finance
1. Stock Valuation: 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.
2/100 + 120-100/100 =
2/100+20/100=22/100
.02 + .2 = .22%
Dividend yield is .02 %
Capital gains yield - .2%
Total Return is .22%
2. Total Return: You bought a share of 4% preferred stock for $100 last year. The market price for your stock is now $120. What was your total return for last year?
$120-100/100
20/100
.2
Or 20%
3. CAPM: A stock has 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?
5% +1.2 (12%-5%)
5% +1.2(7%)
5% + 8.4% = 13.4%
4. WACC: 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)?
80%/80% +20@ x 12% +20%/80%+20% x 7% (1-30%)
.80/.80+.20x .12 = .20/.80+.20 x.07 (1-.30)
.80/1 x .12 = .20/1 x .07 (.70)
.80 x .12 + .20 x .07 (.70)
.96 + .20 x .049
.096 + .0098
.1058
10.58%
5. Flotation Costs: 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%. The flotation cost on new debt is 4%. What is the initial cost of the plant if the company raises all equity externally?
[DebtFC x (Debt Equity Ratio)/(1+ Debt Equity Ratio)] + [EquityFC x (1/1+Debt Equity Ratio)]
4% x (.75) / (1 + .75) +10% x 1/1 +.75
.04 x (.75) / 1.75 +.10 x 1/1 +.75
.03 / 1.75 + .10 x 17.5
.03 / 1.75 + .10 x 17.5
.03/19.25
641.67
