Question

You purchase 100 shares of stock for $40 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) $38; (ii) $40; (iii) $46? (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 3%? (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

Answer:

a (i) 0%

a (ii) 5%

a (iii) 20%

a (i) - 2.91%

a (ii)  1.94%

a (iii)  16.51%

Explanation:

The computation is shown below:

a (i) Rate of return = (End year stock price - purchase price) + dividend ÷ (purchase price)

= ($38 - $40) + $2 ÷ 40

= 0%

a (ii) Rate of return = (End year stock price - purchase price) + dividend ÷ (purchase price)

= ($40 - $40) + $2 ÷ 40

= 5%

a (iii) Rate of return = (End year stock price - purchase price) + dividend ÷ (purchase price)

= ($46 - $40) + $2 ÷ 40

= 20%

The computation of the real rate of return is shown below:

b. (i) Real rate of return = {( 1 + nominal rate of return) ÷ ( 1+ inflation rate)} - 1

= {( 1 + 0) ÷ ( 1 + 0.03)} - 1

= - 0.029 or - 2.91%

b. (ii) Real rate of return = {( 1 + nominal rate of return) ÷ ( 1+ inflation rate)} - 1

= {( 1 + 0.05) ÷ ( 1 + 0.03)} - 1

=  0.019 or 1.94%

b. (iii) Real rate of return = {( 1 + nominal rate of return) ÷ ( 1+ inflation rate)} - 1

= {( 1 + 0.20) ÷ ( 1 + 0.03)} - 1

= 0.016 or 16.51%