Question 1
Multiple ChoiceAn investor buys one share of a stock for $90. One year later, the stock pays a dividend of $1.80. In the second and third years, the investor receives dividends of $2.10 and $2.40, respectively. At the end of the third year, the investor sells the stock for $98. What is the money-weighted rate of return on this investment, closest to?
Explanation
Explanation
To calculate the money-weighted rate of return, apply the internal rate of return (IRR) to the following cash flow timeline:
Cash Flows (in $):
Year 0: –90
Year 1: +1.80
Year 2: +2.10
Year 3: +2.40 + 98 = +100.40
Enter these into a financial calculator using the CF (Cash Flow) worksheet:
CF₀ = –90
CF₁ = 1.80
CF₂ = 2.10
CF₃ = 100.40
Solve for IRR → IRR ≈ 7.26%
When solving for IRR be sure to click IRR then press CPT on the BAII Plus. Additionally to store each CF be sure to press enter. You can also navigate the cash flows via the arrows.
Last peace of advice. Make sure that the first CF is negative. If it is not, the calculation will error out.
This IRR represents the money-weighted return, as it reflects the timing and magnitude of all cash inflows and outflows over the investment period.
Question 2
Multiple ChoiceAn investor gathers the following information about a stock:
Time (t) | Stock Price | Dividend Paid
t = 0 | $25 | —
t = 1 | $2 | $2
t = 2 | $24 | $1
The investor purchased one unit of the stock at time 0 and sold it at time 2. If the dividends were not reinvested, the money-weighted rate of return is closest to:
Explanation
To find the money-weighted rate of return (MWRR), treat this as an IRR problem:
Cash flows:
CF₀ = –25 (purchase)
CF₁ = +2 (dividend at t=1)
CF₂ = +24 + 1 = +25 (price + dividend at t=2)
Steps on the BAII Plus
CF → 2nd CLR WORK
CF₀ = –25 → ENTER
↓
CF₁ = 2 → ENTER
↓
CF₂ = 25 → ENTER
↓
IRR → CPT → 11.96% ≈ 12%