Question

# You purchase 100 shares of stock for \$25 a share. The stock pays a \$2 per...

You purchase 100 shares of stock for \$25 a share. The stock pays a \$2 per share dividend at year-end.

a. What is the rate of return on your investment if the end-of-year stock price is (i) \$23; (ii) \$25; (iii) \$28? (Leave no cells blank - be certain to enter "0" wherever required. Enter your answers as a whole percent.)

b. What is your real (inflation-adjusted) rate of return if the inflation rate is 5%? (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places. Negative amounts should be indicated by a minus sign.)

a)

 (i) (ii) (iii) Number of shares 100 100 100 Buying Price (BP) 25 25 25 Dividend Paid (D) 2 2 2 Selling Price (SP) 23 25 28 Return \$ (= SP - BP + D) 0 2 5 Return% = Return\$/BP % 0.00% 8.00% 20.00%

b)

In order to calculate Real rate of return, you need to use the formula

When stock price is 23, Real rate of return = ((1 + 0%) / (1 + 5%)) -1 = - 4.76%

When stock price is 25, Real rate of return = ((1 + 8%) / (1 + 5%)) -1 = 2.86%

When stock price is 28, Real rate of return = ((1 + 20%) / (1 + 5%)) -1 = 14.29%

In some textbooks, you will also read a simplified form of Real rate of return, which is:

Nominal rate of Return = Real Rate of Return + Inflation

This is an approximate version, whereas the one we used to calculate is the accurate form.