Question

An investor buys 400 shares of stock selling at $70 per share using a margin of 40%. The stock pays annual dividends of $2 per share. A margin loan can be obtained at annual interest cost of 6%. Determine what return on invested capital the investor will realize if the price of the stock increases to $94 within twelve months.

A. 33.54%

B. 34.29%

C. 37.14%

D. 55.90%

E. 83.86%

Answer 1

Invested capital = number of shares bought * purchase price per share * margin %

Invested capital = 400 * $70 * 40%

Invested capital = $11,200

Margin loan = number of shares bought * purchase price per share * (1 - margin %)

Margin loan = 400 * $70 * (1 - 40%)

Margin loan = $16,800

Interest on margin loan for 1 year = Margin loan * interest rate

Interest on margin loan for 1 year = $16,800 * 6%

Interest on margin loan for 1 year = $1,008

Dividends received = number of shares bought * dividend per share

Dividends received = 400 * $2 = $800

Capital gains = number of shares bought * (ending price per share - purchase price per share)

Capital gains = 400 * ($94 - $70)

Capital gains = $9,600

Return on invested capital = (Capital gain + Dividends received - Interest on margin loan) / Invested capital

Return on invested capital = ($9,600 + $800 - $1,008) / $11,200

Return on invested capital = 83.86%