Question

Assume Coca-Cola stock is currently trading at $46 per share and that an investor forecasts future dividends to be $1.80 in year 1 (D₁), $2.00 in year 2 (D₂), and $2.25 in year 3 (D₃) along with an expected stock price at the horizon date of $50 (P₃). What is the implied rate of return to an investor who buys the stock today at its current price if the forecasts are correct?

*Hint: You need to use the internal rate of return (IRR) function in Excel or on the financial calculator.

Answer 1

Implied rate of return is calculated using IRR function as below :

Cash outflow in year 0 = purchase price of stock = $46

Cash inflow in years 1 and 2 = dividends D1 and D2

Cash inflow in year 3 = dividend + expected stock price = D3 + P3 = $2.25 + $50 = $52.25

IRR is 7.06%

Implied rate of return is 7.06%