Rate of Return for Stocks and Bonds
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.
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?
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?
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)?
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?
(125 – 100) + 2.00 / 100 = .27 or 27%
(125-100) / 100 = .25 or 25%
2.00 / 100 = .02 or 2%
rF= 5%
Beta= 1.20
Expected market return= 12%
=5 + 1.20 (12 – 5) = 43.4%
Where:
Re = cost of equity = .12
Rd = cost of debt = .07
E = market value of the firm's equity = .80
D = market value of the firm's debt = .20
V = E + D = total market value of the firm’s financing (equity and debt) = .80 + .20
E/V = percentage of financing that is equity = .80 / (.80+.20)
D/V = percentage of financing that is debt .20 / (.80+.20)
Tc = corporate tax rate = .30
WACC = (.80/1) * .12 + (.20/1) * 7 * (1 – .30) = .8 * .12 + .2 * .07 * .7 = .0145 or 1.45
