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%