USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Shares of RossCorp stock are selling for $45 per share. Brokerage commissions are 2 percent for purchases and 2 percent for sales. The interest rate on margin debt is 6.25 percent per year. The maintenance margin is 30 percent.
-Refer to Exhibit 3.7. At the end of one year, shares of RossCorp stock are selling for $55 per share and the company paid dividends of $0.85 per share. Assuming that you borrowed 25 percent of cost of the purchase, what is your rate of return?
A) -23.51 percent
B) 29.35 percent
C) 23.51 percent
D) 5.21 percent
E) 10.06 percent

Question

Quizplus · Accepted Answer

First, we need to calculate the initial cost of the purchase.
Initial cost per share = $45 + (2% of $45) = $45.90
25% of the initial cost = $11.48 (amount borrowed)
Net amount invested = $34.42 ($45.90 - $11.48)
Number of shares purchased = $34.42/$45 = 0.765 shares

At the end of one year:
The value of shares = 0.765 x $55 = $42.08
Dividend earned = 0.765 x $0.85 = $0.65
Total value of the investment = $42.08 + $0.65 = $42.73

Margin call price (30% maintenance margin) = $45 x (100% - 30%) = $31.50
Margin interest paid (6.25%) = $11.48 x 6.25% = $0.72
Brokerage commissions (buying and selling) = ($45.90 + $55.00) x 2% = $2.00

Total expenses = $11.48 + $0.72 + $2.00 = $14.20

Rate of return = (($42.73 - $34.42 - $14.20) / $34.42) x 100% = 23.51% (Option C)