Anita Vasquez received $130,000 from her mother's estate. She placed the funds into the hands of a broker, who purchased the following securities on Anita's behalf:
| a. |
Common stock was purchased at a cost of $65,000. The stock paid no dividends, but it was sold for $150,000 at the end of four years.
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| b. |
Preferred stock was purchased at its par value of $18,000. The stock paid a 8% dividend (based on par value) each year for four years. At the end of four years, the stock was sold for $13,500.
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| c. |
Bonds were purchased at a cost of $47,000. The bonds paid $2,820 in interest every six months. After four years, the bonds were sold for $53,000.
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The securities were all sold at the end of four years so that Anita would have funds available to start a new business venture. The broker stated that the investments had earned more than a 22% return, and he gave Anita the following computation to support his statement:
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| Common stock: |
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| Gain on sale ($150,000 - $65,000) |
$ |
85,000 |
| Preferred stock: |
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| Dividends paid (8% × $18,000 × 4 years) |
|
5,760 |
| Loss on sale ($13,500 - $18,000) |
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(4,500) |
| Bonds: |
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| Interest paid ($2,820 × 8 periods) |
|
22,560 |
| Gain on sale ($53,000 - $47,000) |
|
6,000 |
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| Net gain on all investments |
$ |
114,820 |
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$114,820 ÷ 4 years
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= 22.1% |
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$130,000 |
| Required: |
| 1a. |
Using a 22% discount rate, compute the net present value of each of the three investments.
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| |
Net Present Value |
| Common stock |
$ |
| Preferred stock |
$ |
| Bonds |
$ |
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| 1b. |
On which investment did Anita earn a 22% rate of return? |
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Common stock |
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Preferred stock |
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Bonds |
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None |
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| 2. |
Considering all three investments together, did Anita earn a 22% rate of return? |
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| 3. |
Anita wants to use the $216,500 proceeds 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 14% return over the 10-year period? Assume that the project will yield same annual cash inflow each year. Anita will not receive back her original investment at the end of the contract.
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