Clark received $175,000 from her mothers estate. She placed the funds into the hands of a broker,

Question:

Clark received $175,000 from her mother’s estate. She placed the funds into the hands of a broker, who purchased the following securities on Linda’s behalf:

(a) Common stock was purchased at a cost of $95,000. The stock paid no dividends, but it was sold for $160,000 at the end of three years.

(b) Preferred stock was purchased at its par value of $30,000. The stock paid a 6% dividend (based on par value) each yeas for three years. At the end of three years. The stock was sold for $27,000.

(c) Bonds were purchased at a cost of $50,000. The bonds paid $3,000 in interest every six months. After three years, the bonds were sold for $52,700. (Note: In discounting a cash flow that occurs semiannually, the procedure is to halve the discount rate and double the number of periods. Use the same procedure in discounting the proceeds from the sale.)

The securities were all sold at the end of three years so that Linda would have funds available to open a new business venture. The broker stated that the investments had earned more than a 16% return, and he gave Linda the following computations to support his statement:

Common stock: $65,000 Gain on sale ($160,000 – $95,000) Preferred stock: Dividends paid (6% × $30,000 x 3 years). 5,4

Required:

1. Using a 16% discount rate, compute the net present value of each of the three investments. On which investment(s) did Linda earn a 16% rate of return? (Round computations to the nearest whole dollar.)

2. Considering all three investments together, did Linda earn a 16% rate of return? Explain.

3. Linda wants to use the $239,700 proceeds ($160,000 + $27,000 + $52,700 = $239.700) from sale of the securities to open a retail store under a 12-year franchise contract. What annual net cash inflow must the store generate for Linda to earn a 14% return over the 12-year period? Round computations to the nearest whole dollar.

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