Return on Invested Capital From a Margin Transaction
Category: Business and Money > Finance
Asked by: loman-ga
List Price: $25.00
24 Jul 2005 20:09 PDT
Expires: 23 Aug 2005 20:09 PDT
Question ID: 547429
Ed Delahanty purchased 500 shares of Niagara Corporation stock on margin at the beginning of the year for $30 per share. The initial margin requirement was 55%. Ed paid 13% interest on the margin loan and never faced a margin call. Niagara paid dividends of $1 per share during the year. 1. At the end of the year, if Ed sold the Niagara stock for $40 per share, what would Ed's rate of return be for the year? 2. At the end of the year, if Ed sold the Niagara stock for $20 per share, wht would Ed's rate of return be for the year? 3. Recalculate your answers for (1) and (2) assuming that Ed made the Niagara stock purchase for cash instead of on margin.
Re: Return on Invested Capital From a Margin Transaction
Answered By: omnivorous-ga on 25 Jul 2005 10:11 PDT
Loman ? Niagara stock purchase = $15,000 Ed invests = $8,250 Ed borrows = $6,750 1. Ed sells at $40/share: Niagara sale price = $20,000 Dividends = $500 Interest = 0.13 * $6,750 = $877.50 Profits = $5,000 + $500 - $877.50 = $4,622.50 Return = $4,622.50 / $8,250 = 56.0% 2. Ed sells at $20/share: Niagara sale price = $10,000 Dividends = $500 Interest = 0.13 * $6,750 = $877.50 Profits = -$5,000 + $500 -$877.50 = - $5,377.50 Return = - $5,377.50 / $8,250 = - 65.2% 3. The cash purchase percentages assume no interest payments ? but also increase the investment to $15,000: Ed sells at $40/share: Profits = $5,500 Return = $5,500 / $15,000 = 36.7% (lower than case #1) Ed sells at $20/share Profits = -$4,500 Return = -$4,500 / $15,000 = - 30.0% (lower negative return than case #2) Best regards, Omnivorous-GA
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