You purchased 1000 shares of stock in Cumberland Software for $3 per share on Ja
ID: 2750479 • Letter: Y
Question
You purchased 1000 shares of stock in Cumberland Software for $3 per share on January 1, 2006. Over the next four years you received 7 cents per share annually in dividends. On December 31, 2009 you sell all your shares of Cumberland Software for $16.50 per share. Brokerage commissions are 4% of the total transaction value when buying and selling. Now, determine your net return (after taxes and inflation) on Cumberland Software. Assume a marginal tax rate of 31% and a rate of inflation over the four year period of 3.75% per year. (A 31% marginal tax bracket consumer would be taxed 15% for both dividends and capital gains.)
Explanation / Answer
Purchase Price on January 1, 2006 = $ 3
Number of Shares purchased = 1000
Annual Dividends received = $ 0.07 per share
Sale Price of Shares on 31st December 2009 = $ 16.50
Tax rate on dividends and Capital Gains = 15%
Inflation rate = 3.75% per annum
Brokerage commission = 4% of total transaction value
Net Purchase Value = No of Shares * Purchase Price + (No of shares *Purchase price)*brokerage
Net Purchase value = 1000 * 3 + (1000*3)*4% = 3000 + 120 = $ 3120
Annual Dividend amount received = (Number of Shares * Dividend per share) * (1-Tax rate)
= (1000 * 0.07) * (1-0.15) = 70 * 0.85 = $ 59.50
Total Dividend received = $ 59.50 * 4 = $ 238
Net Sales Value = (Number of Shares * Sale Price) – (Number of Shares * sales price)*brokerage
= (1000 * 16.50) – (1000*16.50)*0.04
= 16500 – 660
= $ 15840
Capital gains tax payable = (Net Sales Value – Net Purchase value) * Tax rate
= ($ 15840 - $3120) * 0.15
= $ 1908
Net after tax sales value received =$ 15840 - $ 1908 = $ 13932
Net return = ((Net after tax sales value - Net purchase price) + Total after tax dividend received) / Net Purchase price
Net return = (($13932 - $ 3120) + $ 238) / $ 3120
= ($10812 + $238)/$3120 = $11050/$3120
= 3.54166667
Net inflation and tax adjusted return = [Net return/(1+inflation rate)^4] – 1
= [3.54166667/(1+0.0375)^4] – 1
= [3.54166667/1.158650415] – 1
= 3.056717212 – 1 = 2.056717212 or 205.67% (rounded off)
Annual inflation and tax adjusted return = (3.056717212)^(1/4)-1 = 1.32225-1
= 0.32225 or 32.23%
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