CASE 13-32 Net Present Value Analysis of Securities [LO1] Anita Vasquez received $160,000 from her mother's estate. She placed the funds in the hands of a broker, who purchased the following securities on Vasquez's behalf: a. Common shares were purchased at a cost of $80,000. The shares paid no dividends, but they were sold for $180,000 at the end of four years. b. Preferred shares were purchased at their par value of $30,000. 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 $24,000. c. Bonds were purchased at a cost of $50,000. The bonds paid $3,000 in interest every six months. After four years, the bonds were sold for $58,500. (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 ($180,000 $80,000) . . . . . . . . . . . . . . . . . . . . . . . . . $100,000 Preferred shares: Dividends paid (6% $30,000 4 years) . . . . . . . . . . . . . . . . . . . . 7,200 Loss on sale ($24,000 $30,000) . . . . . . . . . . . . . . . . . . . . . . . . . . (6,000) Bonds: Interest paid ($3,000 8 periods) . . . . . . . . . . . . . . . . . . . . . . . . . . . 24,000 Gain on sale ($58,500 $50,000) . . . . . . . . . . . . . . . . . . . . . . . . . . 8,500 Net gain on all investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $133,700 Return: ($133,700 4) $160,000 = 20.9% WWW.TEX-CETERA.WS 628 Chapter 13 Capital Budgeting Decisions Required: Ignore income taxes. 1. Using a 20% discount rate, compute the net present value of each of the three investments. On which investment(s) did Anita earn a 20% rate of return? (Round computations to the nearest whole dollar.) 2. Considering all three investments together, did Anita earn a 20% rate of return? Explain. 3. Anita wants to use the $262,500 in proceeds ($180,000 + $24,000 + $58,500 = $262,500) 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. (Round computations to the nearest whole dollar.)