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.
Resources: Corporate Finance
Calculate the following problems and provide an overall summary of how companies make financial decisions in no more than 700 words, based on your answers:
- 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.
Explanation & Answer
Running head: RATE OF RETURN FOR STOCKS AND BONDS.
Rate of Return for Stocks and Bonds
[Your name here]
February 27, 2017
RATE OF RETURN FOR STOCKS AND BONDS
Stock valuation is determining the monetary worth of a company. It includes; evaluation
of management, future earnings, assets and capital structure (Investopedia.com, 2016). While
there are many methods, the comparables method is the most versatile (Investopedia.com, 2016).
The main categories for stock valuation based on fundamentals are relative valuation and
absolute valuation. They involve dividends, growth rate, and dividends of the business
(Investopedia.com, 2016). However, the application is different since stocks are different in
nature and industries unique which demand different valuation approach (Investopedia.com,
CAPM (Capital Asset Pricing Model)
CAPM shows the relationship between risky assets and expected returns. The rate
discounts future cash ...