Question

Rate of Return for Stocks and Bonds

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

Calculate the following problems using Excel or a Word document:

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?

Submit your summary and all calculations. Please show all of your work.

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Answer 1

1-	total returnin percentage	(dividend income+(selling price-purchase price)]/ purchase price	(2+25)/120	22.50%
	Dividend Yield	dividend/purchase price	2/120	1.67%
	capital gain Yield	capital gain/ purchase price	(125-100)/120	20.83%
2-	total return for last year	(selling price-purchase price)/ market price	(120-100)/100	20%
3-	expected return on stock	risk free rate+(market return-risk free rate)*beta	5+(12-5)*1.2	13.40
4-	after tax cost of debt	7*(1-.3)	4.9
	cost of equity		12
	source	weight	cost	weight*cost
	debt	0.2	4.9	0.98
	common stock	0.8	12	9.6
	WACC	sum of weight*cost		10.58
5-	Debt equity ratio	.75 : 1
	total of funds required	1+.75	1.75
	Amount of equity	(125*1/1.75)	71.42857
	amount of equity to be raised externally	amount required/(1-flotation cost)	71.42857/.90	79.36508
	amount of debt required	(125*.75)/1.75	53.57143
	amount of debt to be raised	amount required/(1-flotation cost)	53.5714/(1-.04)	55.80354
	total funds to be raised	79.365+55.803		135.1686