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 calcluations.
Please Follow the Grading Rubic sheet.
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Explanation & Answer
Here is the answer. Thank you
Requirement 01: Dividend Yield, Capital Gain, and Total Gain on Stock Investment
The dividend yield is the percentage of dividend income as percentage of stock price
(Nobles, Mattison, & Matsumura, 2014). The dividend yield of the stock is 2%. The capital gain
is the income derived from the appreciation of the value of stock price (Petty, Titman, Keown, &
Martin, 2015). The capital gain of the stock is 25%. Total gain is the sum of dividend yield and
capital gain (McMenamin, 2013). Total gain from the investment in stock is 27 (2%+25%).
Requirement 02: Total Return on Preferred Stock
Total return on preferred stock is the sum of dividend yield plus capital gain (Nobles,
Mattison, & Matsumura, 2014). The dividend yield and capital gain of the preferred stock
investment are 4% and 20% respectively. Total gain on the preferred stock investment is 24%
(4% + 20%).
Requirement 03: Expected Rate of Return on Stock under CAPM Approach
The capital assets pricing model (CAPM) states that the expected rate of return of an
stock is the summation of risk free rate and risk pre...