Assume that $10,000 was invested in the stock of General Medical Corporation wit

Question

Assume that $10,000 was invested in the stock of General Medical Corporation with the intention of selling after one year. The stock pays no dividends, so the entire return will be based on the price of the stock when sold. The opportunity cost of capital on the stock is 10 percent. A) Assume that the stock sale nets $11,500. What is the dollar return on the stock investment? What is the rate of return? B) Assume that the stock price falls and the net is only $9,500 when the stock is sold. What is the dollar return and rate of return? C) Assume that the stock is held for two years. Now, what is the dollar return and rate of return?

Explanation / Answer

A. Sale price = $11500
dollar return = 11500 - 10000 = $1,500
rate of return = 1500/10000 * 100 = 15%

B. sale price = $9500
dollar return = 9500 - 10000 = -500
rate of return = -500/10000 * 100 = -5%

C. 1st case when the dollar return is 1500 in two years

10000 (1+r)^2 = 11500
(1+r)^2 = 1.15
1+r = 1.15^0.5 = 1.0723
r = 0.0723 or 7.23%

2nd case when the dollar return is -500 in 2 years
10000(1+r)^2 = 9500
(1+r)^2 = 0.95
1+r = 0.95^0.5 = 0.9747

r = 0.9747 - 1 = -0.0253 or -2.53%

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