Dollar-Weighted Rate of Return Calculation for Microscam Investment

Dollar-Weighted Rate of Return Calculation

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Question

An investor purchases 500 shares of Microscam common stock for $58.74 per share at t0. At t1, dividends of $1.20 per share are received on the 500 shares owned and the investor purchases an additional 340 shares at $60.12 per share, At t2, dividends of $1.20 are received on the 840 shares owned and he purchases another 60 shares for $55.14 per share. At t3, the investor sells 500 shares of Microscam for $61.25 per share and the other 400 shares for $62 per share. No dividend are received at t3. Assuming no taxes or commissions, what is the dollar-weighted rate of return for this investment?

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Explanation

Remember that the dollar-weighted rate of return uses the IRR equation in the determination of the answer. Further, the dollar-weighted rate of return is another name for the IRR equation, and this nomenclature is commonly used within the field of investment management. In the determination of the dollar-weighted rate of return calculation, the first step should be to identify the cash flows for each period. This process is illustrated as follows: t0: {-[500 shares purchased * $58.74 per share] = ($29,370.00) t1: {-[340 shares purchased * $60.12 per share] + [$1.20 per share dividend * 500 shares] = ($19,840.80) t2: {-[60 shares purchased * $55.14 per share] + [$1.20 per share dividend * 840 shares]} = ($2,300.40) t3: {[500 shares sold * $61.25 per share] + [400 shares sold * $62 per share] = $55,425.00

Now that the cash flows have been determined, incorporating this information into your calculator's cash flow worksheet and solving for IRR will yield a dollar- weighted rate of return of 2.94% for this investment.

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