Reference no: EM133056555

We have done some examples of holding period returns in class, and this assignment will ask you to calculate this number for several investments. As a reminder, a holding period return is the total return you earn on your investment over the time period you own it. The calculation is: (Sale price + Dividends or coupon payments) / Purchase Price - 1.

So for example, if I buy a stock for $10, receive $1 in dividends, and sell it for $12, my holding period return is (12 + 1) / 10 - 1 = 30%.

2. You are considering an investment in the stock market. Your friend has been touting his investment in Altria Group, a large and profitable dividend paying company but one that has no growth. Altria currently pays a dividend of $4/share (this is the annual cash flow), and anticipates maintaining that same dividend for the foreseeable future (no growth).

a. Using a cost of capital of 8% and the perpetuity formula, what price should you expect to pay for one share of Altria stock?

b. If you sell your shares one year from now, what price would you expect to receive for those shares assuming the cost of capital has not changed?

c. What would your holding period return be if you buy Altria at the current price, hold for one year, and then sell? (Remember to include the dividend payment as part of your return.)

d. Redo the analysis above instead using a 6% cost of capital. How does this change your holding period return? You decide you are not a big fan of investing in the tobacco industry, and instead choose to buy shares of Apple. Apple pays a $2 dividend (this is the cash flow expected one year from now) and the company is expected to grow its revenues, earnings, and dividends by 6% every year. Use a 10% cost of capital for Apple.

e. What price should you expect to pay for Apple stock?

f. If you sell your Apple shares one year from now, what price would you expect to receive for those shares assuming the cost of capital and growth rate has not changed? (Keep in mind, the dividend is growing each year - you have a different starting dividend.)

g. What is the price return, in percent, for Apple stock over this one-year period? (Price in 1 year / price today - 1).

h. What is the total holding period return if you buy Apple stock at the current price, hold for one year, and then sell? (Include both the price change and the dividend payment.) How does this compare to the cost of capital?

i. Redo the analysis for Apple using a 15% cost of capital. What is your price return and holding period return now?