# Return on Stock, WACC, Payout Ratio Questions

3. What is the percentage total return on a stock that had an initial price of $70 per share, paid a dividend of $2.50 per share for the year, and had an ending price for the year of $74.50?

5. What is the expected rate of return on a portfolio where 20% is invested in Stock X, 30% in Stock Y, and 50% in Stock Z if the expected returns on the three stocks are 10%, 18%, and 13%, respectively?

6. You need to decide whether to purchase a particular machine which will be obsolete in 10 years no matter what you do. The machine will increase your cash flow by $180,000 per year. The machine costs $1,000,000 today, but will decrease in price by $100,000 per year until it reaches a price of $500,000 where it will remain for the remainder of the time it is useful. If your required rate of return is 12%, should you purchase the machine, and if so, when?

7. What is a company?s payout ratio if it just declared an annual dividend of $0.50 on an earnings per share of $8?

8. What is a company?s cost of equity if it has no debt, but can borrow at 9%, and has a WACC of 15%, and a tax rate of 35%? What would the cost of equity be if the firm converted to 25% debt?

9. What is a company?s cost of equity if it just issued a dividend of $2.50 per share on a share valued currently at $40, and where the company is expected to maintain a 7% growth rate in that dividend indefinitely?

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#### Solution Preview

3. What is the percentage total return on a stock that had an initial price of $70 per share, paid a dividend of $2.50 per share for the year, and had an ending price for the year of $74.50?

Percentage Total return = Total Income/Initial Investment

The total income is the dividend of $2.50 and the gain from the increase in share price of $4.50. The total income is $7. The initial investment is $70.

Percentage Total return = 7/70=10%

5. What is the expected rate of return on a portfolio where 20% is invested in Stock X, 30% in Stock Y, and 50% in Stock Z if the expected returns on the three stocks are 10%, 18%, and 13%, respectively?

Expected Return on Portfolio = Sum(percentageXexpected return)

multiply the percentage investment of each stock by its respective return and add up all the resultant figures.

Expected Return = 0.20X10% + 0.30 X 18% + ...

#### Solution Summary

The solution has questions relating to return on stock, WACC and payout ratio.

Finance Questions

(See attached file for full problem description)

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Problem 6-3

Preferred Stock. Preferred Products has issued preferred stock with an $8 annual dividend that

will be paid in perpetuity.

a. If the discount rate is 12 percent, at what price should the preferred sell?

b. At what price should the stock sell 1 year from now?

c. What is the dividend yield

capital gains yield

expected rate of return

of the stock?

Problem 6-10

Stock Values. Integrated Potato Chips paid a $1 per share dividend yesterday. You expect the

dividend to grow steadily at a rate of 4 percent per year.

a. What is the expected dividend in each of the next 3 years?

b. If the discount rate for the stock is 12 percent, at what price will the stock sell?

c. What is the expected stock price 3 years from now?

d. If you buy the stock and plan to hold it for 3 years, what payments will you receive?

What is the present value of those payments? Compare your answer to (b).

PMT YR1

PMT YR2

PMT YR3

PV of PMTs

Problem 6-19

Constant-Growth Model. Here are data on two stocks, both of which have discount rates of 15%:

Stock A Stock B

Return on equity 15% 10%

Earnings per share $2.00 $1.50

Dividends per share $1.00 $1.00

Stock A Stock B

a. What are the dividend payout ratios for each firm?

b. What are the expected dividend growth rates for each firm?

c. What is the proper stock price for each firm?

Problem 12-5

Calculating WACC. Reactive Industries has the following capital structure. Its corporate tax rate is 35 percent. What is its WACC?

Security Market Value Required Rate of Return

Debt $20,000,000 6.00%

Preferred stock $10,000,000 8.00%

Common stock $50,000,000 12.00%

WACC FORMULA

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