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

a) Total return = Dividend Yield + Capital Gain Yield = 2/100 + (115-100)/100 = 17%
b)Real rate = ( 1+ Nominal rate )/( 1+inflation) - 1 = ( 1+17%)/(1+ 5%) - 1 = 11.43%
c) After Tax real return
Total return after taxes = 17% * ( 1-15%) = 14.45%
Real rate = ( 1+ Nominal rate after tax )/( 1+inflation) - 1 = ( 1+14.45%)/(1+ 5%) - 1 = 9%

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