Question

Assume a stock is initially priced at 50 and pays an annual dividend. An investor uses cash to pay 25 a share and borrows the remaining funds at a 12 percent annual interest. What is the return if the investor sells the stock for 55 at the end of one year?

Answer 1

The return on investment for selling the stock can be calculated by subtracting the interest expense on borrowed funds from the gain of selling the stock, dividing it by the total cost of purchasing the stock, and expressing it as a percentage.

Step-by-step explanation:

To calculate the return on investment, we need to determine the total cost of purchasing the stock and the total gain from selling it. The investor pays $25 per share, so the total cost would be $25. The remaining funds are borrowed at a 12% annual interest rate. At the end of one year, the investor sells the stock for $55, resulting in a $5 gain per share. However, we also need to account for the interest expense on the borrowed funds. The interest expense would be 12% of the difference between the purchase cost ($25) and the gain from selling the stock ($5), which is $3.60.

Therefore, the net gain from selling the stock is $1.40 per share ($5 gain - $3.60 interest expense). To calculate the return on investment, we divide the net gain by the total cost of purchasing the stock and express it as a percentage:

Return (%) = (Net Gain / Total Cost) x 100

Return (%) = ($1.40 / $25) x 100 = 5.6%