Question

Kathy Myers frequently purchases stocks and bonds, but she is uncertain how to determine the rate of return that she is earning. For example, three years ago she paid $24,000 for 890 shares of Malti Company’s common stock. She received a $837 cash dividend on the stock at the end of each year for three years. At the end of three years, she sold the stock for $25,000. Kathy would like to earn a return of at least 13% on all of her investments. She is not sure whether the Malti Company stock provide a 13% return and would like some help with the necessary computations.

Click here to view Exhibit 14B-1 and Exhibit 14B-2, to determine the appropriate discount factor(s) using tables.

Required:

1. Compute the net present value that Kathy earned on her investment in Malti Company stock.

2. Did the Malti Company stock provide a 13% return?

Answer 1

The following are the details given.
a) Three years ago Kathy Myers has paid $24,000 for 890 shares of Malti Company's common stock.
b) She received $837 cash dividend on the stock at the end of each year for three years.
c) At the end of three years, she sold the stock for $25,000.
d) Kathy would like to earn a return of at least 14% on all of her investments.
NPV of cash flow = Present value of all future cash in flows over the holdings of investment (-) Present value of cash out flow
Present cash out flow = $ 24,000
Present value of all future cash in flows over the holdings of investment
	(a)	(b)	(a*b)
Year	Cash Inflow	PV Factor @ 13%	Present Value	PV Factor @ r = 13%
1	837	0.8850	740.71	1/ (1+r)^1
2	837	0.7831	655.49	1/ (1+r)^2
3	25,837	0.6931	17,906.34	1/ (1+r)^3
			19,302.54
NPV of cash flow = 19,302-24,000
NPV of cash flow = $ (4,698)
From the above it is clear that the net present value is negative. Hence, the Malti Company stock does not provide a 13% return.