Question

An investor buys 100 shares of stock selling at $50 per share using a margin of 50%. The stock pays its annual dividends of $1.00 per share in 3 months. A margin loan can be obtained at an annual interest cost of 7.75%. Determine what return on invested capital the investor will realize if the stock price increases to $60 within six months

Answer 1

Answer:

The return on invested capital the investor will realize is 40.125%

Explanation:

First calculate the equity and borrowed fund investment

Equity investment = 100 shares x $50 x 50% = $2,500

Borrowed investment = 100 shares x $50 x 50% = $2,500

Now calculate the dividend and interest value

Dividend  = 100 shares x $1 per share = $100

Interest paid = $2,500 x 7.75% x 6/12 = 96.875

Now calculate the price appreciation

Price apreciation = 100 Shares  x ( $60 per share - $50 per share = $1,000

Now use the following formula to calculate the return on investment

Return on investment = ( Dividend - Interest payment + Price apprecaition ) / Equity Investment

Return on investment = ( $100 - $96.875 + $1,000 ) / $2,500

Return on investment = $1,003.125 / $2,500

Return on investment = 0.40125

Return on investment = 40.125%