Question

You are considering 2 investment alternatives. The first is a stock that pays quarterly dividends of $0.25 per share and is trading at $30 per share; you expect to sell the stock in 6 months for $34. The second is a stock that pays quarterly dividends of $0.50 per share and is trading at $27 per share; you expect to sell the stock in 1 year for $30. Which stock will provide the better annualized holding period return?

Answer 1

Answer:

Option 1

Explanation:

The computation is shown below:

For option 1

Dividend received in 6 month is

= $0.25 × 2

= $0.50

Now  

Profit from the sale of stock is

= sale price - purchase price

= $24 - $20 i

= $4

So,

Net proceed received from stock is

= dividend + profit from the sale

= $0.50 + $4

= $4.50

Now

Holding period return for 6 months is

= (Net proceed received ÷ purchase price) ×100

= ($4.50 ÷ $20) × 100

= 22.5 %

So,  

Annualized holding period return is

= 22.5% × 2

= 45%

For  Option 2

Dividend received in 1 year is

= $0.50 × 4

= $2

Profit from sale of stock is

= $30 - $27

= $3

Net proceeds from stock is

= $2 + $3

= $5

So,

Annualized holding period return is

= ($5 ÷ $27) × 100

= 18.52%.

As we can see that option 1 contains higher return so it would be selected