You purchase 100 shares of stock for $50 a share. The stock pays a $4 per share

Question

You purchase 100 shares of stock for $50 a share. The stock pays a $4 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) $46; (ii) $50; (iii) $55? (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 6%? (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.)

Explanation / Answer

a) Rate of return = (capital gain + dividend)/initial share price

So when end of year stock price is $46

return = (46-50+4)/40 = 0

when stock price is 50

return = (50-50+4)/50 = 0.08 or 8%

when stock price is 55

return = (55-50+4)/50 = 0.18 or 18%

b) Real rate of return = (1+nominal rate of return)/(1+inflation rate) -1

given inflation rate is 6%

case 1: real return = (1+0)/(1+.06) - 1 =-0.0566

case 2 real return = (1+.08)/(1+.06) - 1 = 0.0188

case 3: real return = (1+.18)/(1+.06) - 1 = 0.1132

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