Question

Return on I

nvestment

.

Discuss the two components that determine the

return on investment. The components

are

(1) dollar income

-

interest or dividend

paid during the holding period and (2) the change in the value of

investment

.

Answer must be 250 words long and do not plagiarize!!! Answer all parts of question!!

Answer 1

1. Dollar income interest or dividend paid during the holding period

To identify the return on investment, it is important to consider the entire stream of cash inflows and outflows during a given time period. This includes Interest received or dividend income received. The important aspect is to consider the Discount Factor involved for each of the regular income received and the time period for the same.

2. The change in the value of investment

The Overall Change in the value of investment identifies the profitability of the investments in accordance with the expected cash flows and number of years/period it would take to cover the initial costs or achieve a break-even point.

E.g. ABC Corp. decides to invest $100,000 in $100 Stock of Xylo Corp. paying dividend of $1 per share and $50,000 in 5 Year Govt. Bond with 6% interest. The Discount Cash Flow would identify the present value of each dividend:

Year	Dividends	Exp. Return	Total Cash Inflow	Discount Factor 1/(1+r)^n
1	$1,000	$11,000	$12,000	0.900901	$10,810.81
2	$1,000	$11,000	$12,000	0.811622	$9,739.47
3	$1,000	$11,000	$12,000	0.731191	$8,774.30
4	$1,000	$11,000	$12,000	0.658731	$7,904.77
5	$1,000	$11,000	$12,000	0.593451	$7,121.42
6	$1,000	$11,000	$12,000	0.534641	$6,415.69
7	$1,000	$11,000	$12,000	0.481658	$5,779.90
8	$1,000	$11,000	$12,000	0.433926	$5,207.12
9	$1,000	$11,000	$12,000	0.390925	$4,691.10
10	$1,000	$11,000	$12,000	0.352184	$4,226.21
					$70,670.78

Hence, we can identify that even after 10 years, the firm is unable to cover the original cost of investment. Though with the Expected Return of 11% percent it can easily cover the investment, however present value of future returns diminishes the values of future inflows as per the current market value.

Now, if we try to change the value of investment to $50000, the costs can be covered in 8 years.

Amount Invested	$10,000
No. of Stocks	1,000
Per Share	$100
Required Rate of Return	11%
Year	Dividends	Exp. Return	Total Cash Inflow	Discount Factor 1/(1+r)^n
1	$1,000	$1,100	$2,100	0.900901	$1,891.89
2	$1,000	$1,100	$2,100	0.811622	$1,704.41
3	$1,000	$1,100	$2,100	0.731191	$1,535.50
4	$1,000	$1,100	$2,100	0.658731	$1,383.34
5	$1,000	$1,100	$2,100	0.593451	$1,246.25
6	$1,000	$1,100	$2,100	0.534641	$1,122.75
7	$1,000	$1,100	$2,100	0.481658	$1,011.48
8	$1,000	$1,100	$2,100	0.433926	$911.25
					$10,806.86