Question

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.)

Answer 1

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.