Question
Mike Dunlap is considering a leveraged purchase of stock. Today, he can purchase 600 shares of Basket Corporation stock for $30 per share. Since he
Mike Dunlap is considering a leveraged purchase of stock. Today, he can purchase 600 shares of Basket Corporation stock for $30 per share. Since he has only $14,000 in cash, he would like to borrow the rest. Option 1 is to borrow $4000 from a brokerage firm at an annual interest rate of 15 percent.Option 2 is to borrow $3000 from a brokerage firm at an annual interest rate of 12 percent and borrow $1000 from his brother, interest free. Heexpectsthat in one year, he will be able to sell the stock for somewhere between $40 and $50 per share (and no dividends are expected).
What is his annualbefore-taxexpected rate of return on Option 1?
What is Mike's annualbefore-taxexpected rate of return on Option 2?
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