Question

Suppose that the stock of Company X is currently quoted on the Stock Exchangeas follows: bid price is €1.90 and ask price is €1.95. Both of these quotes are for 1000 shares. The commission fees are 0.2% from the value of transaction. Assume that commission fees are deductible for tax purposes. Given the company’s earlier dividend policy, you expect that for the next 2 years Company X will pay dividends of €0.10 per share. For simplicity, lets assume that these dividends will be paid exactly in one year and exactly in two years from now. Assume also that the dividends (cash received) in year 1 and year 2 are not reinvested. Suppose also that you intend to keep the stock exactly for 2 years and then sell it.

According to your expectations the stock of Company X, in exactly 2 years from now, is likely to be quoted on the Stock Exchange as follows: bid price: €2.40 and ask price: €2.45. Both of these quotes are for 1000 shares. Commission fees are expected to remain the same. Suppose that in the country considered, dividends are not taxed while the realized capital gains are taxed at 20% tax rate, whereas the tax is paid at the same time when the capital gains are realized. According to country’s tax regulations, the commission fees paid are deductible for tax purposes. Find your expected after-tax holding period (nominal) total return and the rate of return from investment into 1000 shares of Company X.

Answer 1

	Company X
	Current price	$1.9/1.95
	Nos.	1000
	Now, if an investor invests in 1000 shares
	Cash outflow:
	Purchase value	1950		(1000*1.95)
	Commission	3.9		(1000*1.95)*.2%
	Investment Value=	1953.9
	Cash inflows
	Dividend	200		(.1*1000*2)	Since, amt not reinvested, calc simply for 2 years)
	Sell value($2.4/2.45)	2450		(1000*2.45)
	Less: Commission	-4.9		(2450*.2%)
	Net Cash Inflow=	2645.1
Thus,	Realised yeild over 2 years=
	=	2645.1-1953.9
	=	691.2
	Less: CG tax	20%
	Net realisation in 2 years=	552.96
	Hlding period return=	28.30%
	Yeild p.a.	552.96/2
	=	276.48
		274.48/1953.9*100
	Realised yeild p.a.	14.05%