BFIN620_PPT_CH10_sp09-5

BFIN620_PPT_CH10_sp09-5 - 10- 1 Business Finance 620 Risk,...

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10- 1 Risk, Return and the Risk, Return and the Opportunity Cost of Capital Opportunity Cost of Capital Chapter 10 Brealey-Myers-Marcus 5 th Edition Business Finance 620
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10- 2 Topics Covered Measuring returns on investments Dollar return on investment Total rate of return (or % total return) Holding period rate of return Rates of return and inflation Capital market history Measuring investment risk Total risk Risk specific to the firm Market risk Risk and diversification
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10- 3 Dollar Return on Investment Return on investment has two components: Income Price change (capital gain or loss) Income would include interest payments on a bond or cash dividends on common stock. Adding an investment’s dollar income to the dollar change in price yields the total dollar return : Total dollar return = (Investment income) + (Price change)
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10- 4 Total Rate of Return The total rate of return (R 1 ) on a share of common stock can be written in the form: where: P 0 is the purchase (initial) price P 1 is the sale (ending) price DIV is the dividend income paid from the date of purchase to the date of sale - + = 0 0 1 1 P ) P (P DIV 100 ) (R Return of Rate Total
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10- 5 Components of Total Return Total return can be subdivided into 2 parts: An income return (“dividend yield”) A capital gains return (“capital gains yield”) which can be positive or negative. Mathematically, total rate of return becomes: Yield Gains Capital Yield Dividend R P ) P (P 100 P DIV 100 R P ) P (P DIV 100 R 1 0 0 1 0 1 0 0 1 1 + = - + = - + =
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10- 6 Total Rate of Return Application If you buy a stock today for $58 a share, and sell it fifteen months from today for $74, after receiving total cash dividends of $3.35, what is the stock’s total return? Total returns calculated in this manner also are called holding-period returns . The holding (ownership) period is 15 months. During this period, your total return was 33.4%. 33.4% 58 ) 58 (74 3.35 100 R Months 15 = - + =
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10- 7 Total Rate of Return Application The 33.4% total return can be divided into its two component parts. The dividend yield is 5.8% . The capital gains yield is 27.6% . 5.8% 58 3.35 100 Yield Dividend = × = 27.6% 58 58) (74 100 Yield Gains Capital = - × =
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Rates of Return and Inflation Nominal total rates of return (computed from nominal dollars) can be converted into real total rates of return . Real total rates of return remove the effect of inflation, isolating the actual (real) change in purchasing power. With a 2.5% rate of inflation over 15 months, a nominal total return of 33.4% represents a real total rate of return of 30.1% : 30.1% . 1.334
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This note was uploaded on 10/10/2011 for the course BUSINESS 620 taught by Professor Paul during the Spring '11 term at Ohio State.

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BFIN620_PPT_CH10_sp09-5 - 10- 1 Business Finance 620 Risk,...

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