Question

Chaz owns investment A and 1 share of stock B. The total value of his holdings is $350. Stock B is expected to be priced at $90.32 in 2 years, is expected to pay dividends of $12.32 in 1 year and $15.93 in 2 years, and has an annual expected return of 9.60 percent. Investment A has an expected return of R and is expected to pay $63 per year for a finite number of years such that its first annual payment is expected in 1 year from today and its last annual payment is expected in 5 years from today. What is R, the expected return for investment A? Answer as a rate in decimal format so that 12.34% would be entered as .1234 and 0.98% would be entered as .0098.

Answer #1

First, we need to find the price of stock B

P0 = [D1/ (1 + R)] + [(D2+ P2) / (1 + R)^{2}]

D1 = $12.32

D2 = $15.93

P2= $90.32

P0 = [12.32 / 1.0960] + [(15.93 + 90.32) /
(1.0960)^{2}]

= [12.32 / 1.0960] + [106.25 / (1.0960)^{2}] = 11.24 +
88.45 = $99.69

Value of investment A + price of stock B = $350

Value of investment A = $350 - price of stock B = $350 - $99.69 = $250.31

Investment A is an annuity

Time |
0 | 1 | 2 | 3 | 4 | 5 |

Payment # |
1 | 2 | 3 | 4 | 5 | |

Cash Flow |
63 | 63 | 63 | 63 | 63 | |

Present Value |
250.31 |

END mode

Enter 5 63 -250.31 0

N I% PMT PV FV

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