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? b. what is your real (inflation-adjusted) rate of return if the inflation rate is 3%?

A. (i) 0% (ii) 5% (iii) 20%

B. (i) -2.91% (ii) 1.94% (iii) 16.50%

Explanation:

A. The total rate of return of a stock is the net gain (loss) on the investments and it includes both capital gain (loss) and dividend income.

Formula: (Capital Gain (Loss) + Dividend)/Initial Investment

or

(Year End Value + Dividend)/initial investment - 1

Solution:

(i) (38 + 2)/40 - 1 = 0%

(ii) (40 + 2)/40 - 1 = 5%

(iii) (46 + 2)/40 - 1 = 20%

B. Inflation adjusted return is the return on investment after accounting for inflation, it reveals the true earning potential of an investment.

The following formula is used to calculate inflation adjusted return:

Inflation adjusted return = (1 + rate of return) / (1 + inflation rate) - 1

Since, we have already calculated rate of return in Part A we just need to adjust it for inflation

Solution:

(i) (1 + 0%) / (1 + 3%) - 1 = -2.91%

(ii)  (1 + 5%) / (1 + 3%) - 1 = 1.94%

(iii) (1 + 20%) / (1 + 3%) - 1 = 16.50%

*The inflation adjusted return is rounded off to two decimal points*

two years ago, when picking flowers in the mountains back of yosemite valley, i found a book. it was blotted and storm-beaten; all of its outer pages were mealy and crumbly. the paper seemed to dissolve like the snow beneath which it had been buried, however; many of the inner pages were well preserved. and although all were more or less stained and torn, whole chapters were easily readable. this is the condition of the great open book of yosemite glaciers today; its granite pages have been torn and blurred by the same storms that wasted the castaway book.

two years ago, when picking flowers in the mountains back of yosemite valley; i found a book. it was blotted and storm-beaten, all of its outer pages were mealy and crumbly. the paper seemed to dissolve like the snow beneath which it had been buried, however, many of the inner pages were well preserved. and although all were more or less stained and torn; whole chapters were easily readable. this is the condition of the great open book of yosemite glaciers today, its granite pages have been torn and blurred by the same storms that wasted the castaway book.