Christina purchased 500 shares of stock at a price of $62.30 a share and sold the shares one year later for $64.25 each. She also received $738 in dividends. If the inflation rate was 2.9 percent, what was her exact real rate of return on this investment?

Answer

= 5.3%

Explanation

Inflation erodes the value of money. So the real return is calculated by adjusting the the nominal return for inflation rate

The total return on a share is the addition of the capital gain and dividend

For Christiana, the total  real return will be calculated as follows:

Step 1

Total nominal cash inflows

Capital gain = (64.25-62.30) × 500

                   = 975

Dividends =  $738

Total nominal cash inflow = 975 +  $738

               = $1713

Step 2

Real cash inflow

Real return in dollar = (100/102.9)× $1713

                    = $1,664.72   adjusted for inflation

Step 3

Real return in (%)

cost of investment = (500× 62.30) = 31,150

Real rate of return

= real return/cost    ×  100

=(1,664.72/31,150) ×  100

= 5.3%

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