Return Formulas

Question 1

Holding Period Returns

Answer 1

Sell price - (Purchase price + or - Cash Flows) / (Initial Equity)

Not a compounded rate of return

Doesn’t consider time investment was held

Questions will come from margin returns or after tax rate of returns

Question 2

Effective Annual Rate (EAR)

Answer 2

Used when compounding occurs more often than once per year

= (1+i/n)^n - 1

i = stated annual rate
n = # compound periods

Ex: The EAR of 10% compounded quarterly is 10.38%

= (1+.10/4)^4 - 1

Question 3

Geometric Average

Answer 3

On formula sheet, but use time value money buttons on calculator

Time weighted compounded rate return

Question 4

Geometric Average Ex: Yr 1 returned 12%, 2 had 15%, year 3 had -2%

Answer 4

On formula sheet:
[Square root of (1+r1) (1+r2) (1+r3)] - 1 x 100

Calculator way: (Put in 1 Period per year mode)
N = 3
I = ?
PV = make up a # (-1)
PMT = 0
FV = (1.12)(1.15)(.98) = 1.2622

Solve for I/yr = 8.07%

Question 5

NPV

Answer 5

Positive or zero means make the investment

Negative means don’t

Question 6

IRR

Answer 6

Discount rate that sets the NPV equal to zero

NPV=PV of cash flow - initial cost

Can be thought as a compounded rate of return

Used when have uneven cash flows and asked to calculate compounded rate return

Question 7

Dollar Weighted Return

Answer 7

Specific to investor’s return

Considers cash flows over the time period

Solve for IRR

Question 8

Time Weighted Return

Answer 8

Doesn’t consider cash flows over time period

Mutual funds report on time-weighted return basis

It’s the securities’ return, not the investor’s. Assumes a buy and hold

Question 9

Dividend Discount Model

Answer 9

Known as Intrinsic Value Model or Constant Growth dividend model

V=D1/(r-g)

D1 is next expected dividend, Do is current dividend

D1=Do (1+g)

Question 10

Expected Rate of Return

Answer 10

r= (D1 / P) + g

On formula sheet. P is the market price

Question 11

P/E Ratio

Answer 11

Number of $ an investor will pay for each $ of company earnings.

Measures relationship between stock’s price and earnings

Good to value when stock doesn’t pay dividend

Question 12

Expected Price Per Share

Answer 12

EPS x P/E multiplier = Expected price per share

Question 13

If has EPS of $3 and stock price is trading at $40. What’s their P/E Ratio?

Answer 13

PE= Stock price / EPS

= $40/ $3

P/E = 13.3

Question 14

If stock price is trading at $50 and has P/E of 20. What’s their EPS?

Answer 14

P/E = Stock price / EPS

20 = 50 / EPS

EPS = 50 / 20 = $2.50

Question 15

Dividend Payout Ratio

Answer 15

= common stock dividend / EPS

Higher the payout ratio, the more mature the company

High ratio may also mean possibility of dividend being reduced

Question 16

EPS = $2
Common stock dividend=1
Preferred dividend=$.50
Sales is $5,000,000
Shares outstanding 1M
Total Equity $7M

What’s their Dividend payout ratio? What’s their ROE?

Answer 16

= EPS / Common stock Div

= $2 / $1 = 50%

ROE = $2 / (7M / 1M) = 28.5%

Question 17

ROE Formula

Answer 17

= EPS / stockholder equity per share

Measures overall profitability of company

Question 18

Dividend Yield formula

Answer 18

= Dividend per share / stock price