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Solutions to Chapter 10
Introduction to Risk, Return, and the Opportunity Cost of Capital
1.
%
0
.
15
15
.
0
40
$
2
$
)
40
$
44
($
price
share
initial
dividend
gain
capital
return
of
Rate
=
=
+

=
+
=
Dividend yield = dividend/initial share price = $2/$40 = 0.05 = 5%
Capital gains yield = capital gain/initial share price = $4/$40 = 0.10 = 10%
2.
Dividend yield = $2/$40 = 0.05 = 5%
The dividend yield is unaffected; it is based on the initial price, not the final price.
Capital gain = $36 – $40 =

$4
Capital gains yield = –$4/$40 = –0.10 = –10%
3.
a.
%
0
40
$
2
$
)
40
$
38
($
price
share
initial
dividend
gain
capital
return
of
Rate
=
+

=
+
=
%
85
.
3
0385
.
0
1
04
.
0
1
0
1
1
rate
inflation
1
return
of
rate
nominal
1
return
of
rate
Real

=

=

+
+
=

+
+
=
b.
%
5
05
.
0
40
$
2
$
)
40
$
40
($
return
of
Rate
=
=
+

=
%
96
.
0
0096
.
0
1
04
.
1
05
.
1
1
rate
inflation
1
return
of
rate
nominal
1
return
of
rate
Real
=
=

=

+
+
=
c.
%
10
10
.
0
40
$
2
$
)
40
$
42
($
return
of
Rate
=
=
+

=
%
77
.
5
0577
.
0
1
04
.
1
10
.
1
1
rate
inflation
1
return
of
rate
nominal
1
return
of
rate
Real
=
=

=

+
+
=
101
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View Full Document4.
1
rate
inflation
1
return
of
rate
nominal
1
return
of
rate
Real

+
+
=
Costaguana: Real return
%
33
.
8
0833
.
0
1
80
.
1
95
.
1
=
=

=
U.S.: Real return
%
80
.
9
0980
.
0
1
02
.
1
12
.
1
=
=

=
The U.S. provides the higher real rate of return despite the lower nominal rate of
return.
Notice that the approximate relationship between real and nominal rates of return is
valid only for low rates:
real rate of return
≈
nominal rate of return – inflation rate
This approximation incorrectly suggests that the Costaguanan real rate was higher than
the U.S. real rate.
5.
We use the following relationship:
1
rate
inflation
1
return
of
rate
nominal
1
return
of
rate
Real

+
+
=
Asset class
Nominal rate
of return
Inflation rate
Real rate
of return
Treasury bills
4.0%
3.0%
0.97%
Treasury bonds
5.3%
3.0%
2.23%
Common stocks
11.7%
3.0%
8.45%
6.
The nominal interest rate cannot be negative.
If it were, investors would choose to
hold cash (which pays a rate of return equal to zero) rather than buy a Treasury bill
providing a negative return. On the other hand, the
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 Winter '07
 Tennyson
 Opportunity Cost, Corporate Finance, Cost Of Capital

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