Reference no: EM13350193

Question :

Anita Vasquez received $190,000 from her mother's estate. She placed the funds into the hands of a broker, who purchased the subsequent securities on Anita's behalf:

a. General stock was purchased at a cost of $95,000. The stock paid no dividends, but it was sold for $210,000 at the end of four years.

b. Preferred stock was brought at its par value of $24,000. The stock paid a 10 percent dividend (based on par value) every year for four years. At the end of four years, the stock was sold for $20,000.

c. Bonds were brought at a cost of $71,000. The bonds paid $4,260 in interest each six months. After four years, the bonds were sold for $74,000. (Note: In discounting a cash flow that happens semiannually, the process is to halve the discount rate and double the number of periods. Use the same method in discounting the proceeds from the sale.)

The securities were all sold at the completion of four years so that Anita could have funds available to start a new business venture. The broker stated that the investments had earned more than a 20 percent return, and he gave Anita the subsequent computation to support his statement:

Common stock:

Gain on sale ($210,000 - $95,000) $ 115,000

Preferred stock:

Dividends paid (10% × $24,000 × 4 years) 9,600

Loss on sale ($20,000 - $24,000) (4,000)

Bonds:

Interest paid ($4,260 × 8 periods) 34,080

Gain on sale ($74,000 - $71,000) 3,000

Net gain on all investments $ 157,680

$157,680 ÷ 4 years

= 20.7%

$190,000

Evaluate the appropriate discount factor using tables.

Required:

1a.

Using a 20 percent discount rate, evaluate the net present value of each of the three investments. (Negative amounts should be shown by a minus sign. Round discount factors to 3 decimal places, other transitional evaluation and final answers to the nearest whole dollar.)

Net Present Value

Common stock $

Preferred stock $

Bonds $

1b. On which investment did Anita earn a 20 percent rate of return?

Common stock

Preferred stock

Bonds

None

2. Suppose all three investments together, did Anita earn a 20 percent rate of return?

Yes

No

3. Anita needs to use the $304,000 proceeds ($210,000 + $20,000 + $74,000 = $304,000) from sale of the securities to start a fast-food franchise under a 10-year contract. Evaluate net annual cash inflow must the store generate for Anita to earn a 14 percent return over the 10-year period? Suppose that the project will yield same annual cash inflow each year. Anita may not receive back her original investment at the end of the contract.