Figure 123

Cash Flow—An Investment Example in Figure 12.2. These are the same as those in Figure 12.1, except that we have now expressed everything on a per-share basis.

In our example, the price at the beginning of the year was $37 per share and the dividend paid during the year on each share was $1.85. As we discussed in Chapter 8, expressing the dividend as a percentage of the beginning stock price results in the dividend yield:

This says that, for each dollar we invest, we get five cents in dividends.

The second component of our percentage return is the capital gains yield. Recall (from Chapter 8) that this is calculated as the change in the price during the year (the capital gain) divided by the beginning price:

Capital gains yield = (P, + 1 - P,)/P, = ($40.33 - 37)/37 = $3.33/37

So, per dollar invested, we get nine cents in capital gains.

Putting it together, per dollar invested, we get 5 cents in dividends and 9 cents in capital gains; so we get a total of 14 cents. Our percentage return is 14 cents on the dollar, or 14 percent.

To check this, notice that we invested $3,700 and ended up with $4,218. By what percentage did our $3,700 increase? As we saw, we picked up $4,218 - 3,700 = $518. This is a $518/3,700 = 14% increase.

Go to

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Calculating Returns

Suppose you bought some stock at the beginning of the year for $25 per share. At the end of the year, the price is $35 per share. During the year, you got a $2 dividend per share. This is

Ross et al.: Fundamentals I V. Risk and Return I 12. Some Lessons from I I © The McGraw-Hill of Corporate Finance, Sixth Capital Market History Companies, 2002

Edition, Alternate Edition

386 PART FIVE Risk and Return the situation illustrated in Figure 12.3. What is the dividend yield? The capital gains yield? The percentage return? If your total investment was $1,000, how much do you have at the end of the year?

Your $2 dividend per share works out to a dividend yield of:

The per-share capital gain is $10, so the capital gains yield is:

Capital gains yield = (Pt + - Pt)/Pt = ($35 - 25)/25 = $10/25 = 40%

The total percentage return is thus 48 percent.

If you had invested $1,000, you would have $1,480 at the end of the year, representing a 48 percent increase. To check this, note that your $1,000 would have bought you $1,000/25 = 40 shares. Your 40 shares would then have paid you a total of 40 x $2 = $80 in cash dividends. Your $10 per share gain would give you a total capital gain of $10 x 40 = $400. Add these together, and you get the $480 increase.

To give a more concrete example, stock in American Electric Power (AEP) began 2000 at $32.13 a share. AEP paid dividends of $2.40 ($.60 per quarter) during 2000, and the stock price at the end of the year was $46.50. What was the return on AEP for 2000? For practice, see if you agree that the answer is 52.19 percent. Of course, negative returns occur as well. For example, also in 2000, AT&T's stock price at the beginning of the year was $53.38 per share, and 2000 dividends of $.70 per share were paid. The stock ended the year at $17.25 per share. Verify that the loss was 66.37 percent for the year.

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