Question

You are considering the purchase of a certain stock. You expect to own the stock for the next four years. The current market price of the stock is $24.50 and you expect to sell it for $55 in four years. You also expect the stock to pay an annual dividend of $1.25 at the end of year 1, $1.35 at the end of year 2, $1.45 at the end of year 3 and $1.55 at the end of year 4. What is your expected return from this investment?

Answer 1

Answer:

The answer is: The expected rate of return from this investment is 26.68%

Explanation:

We are given the following cash flows for this operation:

• Initial investment = -$24.50
• Cash flow 1 = $1.25 (dividend year 1)
• Cash flow 2 = $1.35 (dividend year 2)
• Cash flow 3 = $1.45 (dividend year 3)
• Cash flow 4 = $56.55 ($1.55 dividend year 4 + $55 stock's sales price)

Using an excel spreadsheet and the IRR function:

=IRR(value 1: value 5) =26.68%  

where

• value 1 = -24.50
• value 2 = 1.25
• value 3 = 1.35
• value 4 = 1.45
• value 5 = 56.55