Dollar Returns

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If you buy an asset of any sort, your gain (or loss) from that investment is called the return on your investment. This return will usually have two components. First, you may receive some cash directly while you own the investment. This is called the income component of your return. Second, the value of the asset you purchase will often change. In this case, you have a capital gain or capital loss on your investment.1

To illustrate, suppose the Video Concept Company has several thousand shares of stock outstanding. You purchased some of these shares of stock in the company at the beginning of the year. It is now year-end, and you want to determine how well you have done on your investment.

First, over the year, a company may pay cash dividends to its shareholders. As a stockholder in Video Concept Company, you are a part owner of the company. If the company is profitable, it may choose to distribute some of its profits to shareholders (we discuss the details of dividend policy in Chapter 18). So, as the owner of some stock, you will receive some cash. This cash is the income component from owning the stock.

In addition to the dividend, the other part of your return is the capital gain or capital loss on the stock. This part arises from changes in the value of your investment. For example, consider the cash flows illustrated in Figure 12.1. At the beginning of the year, the stock was selling for $37 per share. If you had bought 100 shares, you would have had a total outlay of $3,700. Suppose, over the year, the stock paid a dividend of $1.85 per share. By the end of the year, then, you would have received income of:

'As we mentioned in an earlier chapter, strictly speaking, what is and what is not a capital gain (or loss) is determined by the IRS. We thus use the terms loosely.

Ross et al.: Fundamentals V. Risk and Return of Corporate Finance, Sixth Edition, Alternate Edition

12. Some Lessons from Capital Market History

┬ę The McGraw-Hill Companies, 2002

CHAPTER 12 Some Lessons from Capital Market History

Inflows

$4,218 Total

$185

$4,218 Total

$185

Dividends

Dividends

Ending

Time H 0

Initial investment

Outflows - $3,700

0 0

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