Question
Linda Clark received $229,000 from her mothers estate. She placed the funds into the hands of a broker, who purchased the following securities on Lindas
Linda Clark received $229,000 from her mothers estate. She placed the funds into the hands of a broker, who purchased the following securities on Lindas behalf:
a. Common stock was purchased at a cost of $125,000. The stock paid no dividends, but it was sold for $210,000 at the end of three years.
b. Preferred stock was purchased at its par value of $49,000. The stock paid a 7% dividend (based on par value) each year for three years. At the end of three years, the stock was sold for $35,000.
c. Bonds were purchased at a cost of $55,000. The bonds paid annual interest of $1,000. After three years, the bonds were sold for $81,000.
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: | |||
Gain on sale ($210,000 $125,000) | $ | 85,000 | |
Preferred stock: | |||
Dividends paid (7% $49,000 3 years) | 10,290 | ||
Loss on sale ($35,000 $49,000) | (14,000 | ) | |
Bonds: | |||
Interest paid ($1,000 3 years) | 3,000 | ||
Gain on sale ($81,000 $55,000) | 26,000 | ||
Net gain on all investments | $ | 110,290 | |
$110,290 3 years | = 16.10 % |
$229,000 |
Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using tables.
Required:
1-a. Using a 16% discount rate, compute the net present value of each of the three investments.
1-b. On which investment(s) did Linda earn a 16% rate of return?
2. Considering all three investments together, did Linda earn a 16% rate of return?
3. Linda wants to use the $326,000 proceeds ($210,000 + $35,000 + $81,000 = $326,000) from sale of the securities to open a retail store under a 7-year franchise contract. What minimum annual net cash inflow must the store generate for Linda to earn a 11% return over the 7-year period?
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