5. Your next assignment is to assume that $10,000 was invested in the stock of G
ID: 2641051 • Letter: 5
Question
5. Your next assignment is to assume that $10,000 was invested in the stock of General Medical Corporation with the intention of selling after one year. The stock pays no dividends, so the entire return will be based on the price of the stock when sold. The opportunity cost of capital on the stock is 10 percent.
a. To begin, assume that the stock sale nets $11,500. What is the dollar return on the stock investment? What is the rate of return?
b. Assume that the stock price falls and the net is only $9,500 when the stock is sold. What is the dollar return and rate of return?
c. Assume that the sales prices remain the same but the stock is held for two (02) years. Now, what is the dollar return and rate of return?
Explanation / Answer
Amount invested = $10,000
a) Market price of stock = $11,500
Dollar return = P1 - P0
Where P1 = Price at time 1
P0 = Initial investemnt (price at time 0)
Dollar return = $11,500 - $10,000
Dollar return = $1,500
Rate of return = P1 - P0 /P0
Rate of return = 11,500 - 10,000/10,000 x 100
Rate of return = 15%
b) Stock price falls to $9,500
Dollar return = $9,500 - $10,000
Dollar return = - $500
Rate of return = 9,500 - 10,000/10,000 x 100
Rate of return = - 5%
c) Price = $10,000 (remains the same)
Stock held for 2 years
Cost of capital = 10%
Had the investor invested in some other stock the amount would have been :
10,000 (1.1)^2 = $12,100
But the stock remains at $10,000
Dollar Return = $10,000 - $10,000 = 0
Rate of return = $10,000 - 12,100/10,000
Rate of return = 21%
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