QUESTION : The following data pertain to a margin purchase of a stock by an investor : Stock’s purchase price $50/share Sale price $55/share Shares purchased 500 Margin 45% Call money rate 6% Dividend $1.80/share Transaction commission on purchase $0.05/share Transaction commission on sale $0.05/share If the stock is sold exactly one year after the purchase, the total return on the investor’s investment is closest to: A. 14%. B. 19%. C. 22%.
ANSWER : C is correct. Proceeds on sale: $55 x 500 = $27,500 _ Less payoff loan: $50 x 500 x 0.55 = –$13,750 _ Less margin interest paid: $13,750 x 0.06 = –$825 Plus dividend received: $1.80 x 500 = $900 Less sales commission paid: $0.05 x 500 = –$25 Remaining equity = Sum of the above = $13,800 Initial investment (including commission): ($50 x 500 x 0.45) + ($0.05 x 500) = $11,275 Return on the initial investment: ($13,800 – $11,275)/$11,275 = 22.4% My question is why do we have the bolded “Less payoff loan: $50 x 500 x 0.55 = –$13,750” part? In similar questions from other papers, the “Purchase price x Number of shares” was the amount subtracted from “Proceeds on Sale”…but in this question, the amount being subtracted is just the loan portion of the purchase