Question

Demarius owns investment A and 1 share of stock B. The total value of his holdings is 2,017.94 dollars. Investment A is expected to pay annual cash flows to Demarius of 330 dollars per year with the first annual cash flow expected later today and the last annual cash flow expected in 6 years from today.   Investment A has an expected annual return of 13.56 percent. Stock B is expected to pay annual dividends of 38.79 dollars forever with the next dividend expected in 1 year. What is the expected annual return for stock B? Answer as a rate in decimal format so that 12.34% would be entered as .1234 and 0.98% would be entered as .0098.

Answer 1

Demarius owns investment A and 1 share of stock B with the total value of his holdings is $2,017.94

Investment A is expected to pay $330 per year with 1st payment today and other 6 payments at the end of each year.

Calculating the present Value of these Cash flows with 1st payment's Present value will be same while calculating the Present value of other 6 payments:-

Where, C= Periodic Payments = $330

r = Periodic Interest rate = 13.56%

n= no of periods = 6

Present Value = $1628.87

So, Today worth of investment A is $1628.87

Today Worth of Stock B = Total Value of Holding - Today worth of investment A

= $2017.94 - $1628.87

= $389.07

- Expected Dividend of Stock B next year with same amount each year forever = $38.79

Calculating the Expected Annual Return for Stock B:-

Expected Annual Return = Annual Dividend/Current price

= $38.79/$389.07

= 9.97%

So, the expected annual return for stock B is 0.0997

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