Question

The reinvestment of capital gains and dividends can make a significant difference in your total return. Consider the following situation to determine the difference reinvestment can make over a​ five-year period. Initial purchase amount ​$12 comma 000 Initial purchase date January 1 Initial purchase price ​$18.86 per share Annual capital gains distribution rate 1.17​% Annual dividend distribution rate 0.95​% Annual price appreciation rate 7.84​% ​(before distribution) Assume all distributions are made on the last day of the year at the closing net asset value​ (NAV). Ignore tax consequences for the scenarios in a and​ b, below. a. Calculate the ending investment value plus the total of distributions received assuming no reinvestment. b. Calculate the ending investment value assuming all distributions are reinvested. c. Calculate and explain the difference.

Answer 1

Step-by-step explanation:

a.) Ending Investment Value = (1 + 0.0784 ‬)∧5 x 12,000 = 1.0784∧5 x 12000 =$1.4585 x 12,000 =$17,502

Cumulative Annual Dividends Received = 0.0095 x 12,000 x 5 =114 x 5

= $570

Cumulative Annual Distributions Received = 0.0117 x 12,000 x 5 =$140.4 x 5 = $702

Total Value of Portfolio at 5-year end =$17,502 + $570 + $702 =$18,774

b.) Value of Share in the beginning =$18.86

Assuming dividends are invested as soon as they are received,

Amount at the end of first year = 12,000 x 1.0784 + (0.0095+0.0117) x 12,000 = 12,940.8 + 254.4 = 13,195.2

Amount at the end of second year = 13,195.2 x 1.0784 + (0.0095+0.0117) x 13,195.2 = 14,229.7 + 279.74 = 14,509.44

Amount at the end of third year = 14,509.44 x 1.0784 + (0.0095+0.0117) x 14,509.44 = 15,646.98 + 307.6 = 15,954.58

Amount at the end of fourth year =15,954.58 x 1.0784 + (0.0095+0.0117) x 15,954.58 =17,205.42 + 338.24 = 17,543.66

Amount at the end of fifth year = 17,543.66 x 1.0784 + (0.0095+0.0117) x 17,543.66 = 18,919.08 + 371.93 = 19,291.01

c.) The sum in the part-(b) is higher and shows the distinction reinvestment can prompt. With the reinvestment, the profits and other capital increase circulation will gain premium moreover and the exacerbating impact happens on the general contributed sum. This will prompt higher incentive towards the last time frame.