Suppose that an investor purchased 100 shares of IBM stock a

Suppose that an investor purchased 100 shares of IBM stock at a price of $100 on December 31, 2012. During the year 2013, IBM paid dividends of $2.00 per share, and at the end of the year, the investor sold the stock at a price of $115.

A. If there were no taxes or inflation, what was the total return?

B. If there were no taxes but inflation was 5 percent, what was the real return?

C. If the tax rate was 15 percent on dividends and capital gains, what was the after-tax real return? (Hint: Combine the inflation and the taxes to get your answer.)

Solution

Purchase Price = $100

Sale price = $115

Dividend received during year = $2.

Total Return = (Sale price + Dividend received - Purchase price) / Purchase price

= ($115 + $2 - $100) / $100

= $17 / $100

= 17%

Total return on investment is 17%.

b.

Inflation rate = 5%

Real Return = (1 + 17%) / (1 + 5%) - 1

= 1.1143 - 1

= 11.43%

Real Rate of return is 11.43%.

c.

Tax rate = 15%

After tax real return = 11.43% × (1 - 15%)

= 9.71%

After tax real return is 9.71%.