An investor buys stock for $5,000 at the beginning of the year. She earns dividends of $200 during the course of the year. At the end of the year, the stock is worth $5,150. The tax rate on dividends and capital gains is 15 percent. The inflation rate is 2 percent.
a.Calculate the investor's after-tax real return if she does not sell the stock at the end of the year. b.Calculate the investor's after-tax real return if she sells the stock at the end of the year.
What will be an ideal response?
a.Income = dividends + capital gains = $200 + ($5,150 ? $5,000) = $350 Loss of principal value to inflation= inflation rate × principal value = 0.02 × $5000 = $100 Taxes= (0.15 × dividends) + (0.15 × capital gains) = 0.15 × dividends = 0.15 × $200 = $30 After-tax real income = $350 ? $30 ? $100 = $220 After-tax real return = $220/$5,000 = 0.044 = 4.4% b.Taxes= (0.15 × dividends) + (0.15 × capital gains) = 0.15 × income = 0.15 × $350 = $52.50 After-tax real income = $350 ? $52.50 ? $100 = $197.50 After-tax real return = $197.50/$5,000 = 0.0395 = 3.95%.
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