Question
Anita Vasquez received $200,000 from her mothers estate. She placed the funds in the hands of a broker, who purchased the following securities on Vasquezs
Anita Vasquez received $200,000 from her mothers estate. She placed the funds in the hands of a broker, who purchased the following securities on Vasquezs behalf:
- Common shares were purchased at a cost of $100,000. The shares paid no dividends, but they were sold for $225,000 at the end of four years.
- Preferred shares were purchased at their par value of $37,500. The shares paid a 6% dividend (based on par value) each year for four years. At the end of four years, the shares were sold for $30,000.
- Bonds were purchased at a cost of $62,500. The bonds paid $3,800 in interest every six months. After four years, the bonds were sold for $78,500. (Note: In discounting a cash flow that occurs semi-annually, 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 four years so that Vasquez would have funds available to start a new business venture. The broker stated that the investments had earned more than a 20% return annually, and he gave Vasquez the following computation to support his statement:
Common shares: | |||
Gain on sale ($225,000 $100,000) | $ | 125,000 | |
Preferred shares: | |||
Dividends paid (6% $37,500 4 years) | 9,000 | ||
Loss on sale ($30,000 $37,500) | (7,500 | ) | |
Bonds: | |||
Interest paid ($3,800 8 periods) | 30,400 | ||
Gain on sale ($78,500 $62,500) | 16,000 | ||
Net gain on all investments | $ | 172,900 | |
Return: ($172,900 4) $200,000 = 21.6% | |||
(Ignore income taxes.) 1-a. Using a 20% discount rate, compute the net present value of each of the three investments. (Hint: Use Microsoft Excel to calculate the discount factor(s).) (Negative amounts should be indicated by a minus sign. Do not round your intermediate calculations and round final answers to the nearest dollar amount.)
1-b. On which investment did Anita earn a 20% rate of return?
-
Common stock
-
Preferred Stock
-
Bonds
-
None
2. Considering all three investments together, did Anita earn a 20% rate of return?
3. Anita wants to use the $333,500 in proceeds ($225,000 + $30,000 + $78,500 = $333,500) from sale of the securities to open a fast-food franchise under a 10-year contract. What net annual cash inflow must the store generate for Anita to earn a 16% return over the 10-year period? Anita will not receive back her original investment at the end of the contract. (Hint: Use Microsoft Excel to calculate the discount factor(s).) (Do not round your intermediate calculations and round final answer to the nearest dollar amount.)
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