Question

Linda Clark received $223,000 from her mother’s estate. She placed the funds into the hands of a broker, who purchased the following securities on Linda’s behalf:

a. Common stock was purchased at a cost of $99,000. The stock paid no dividends, but it was sold for $161,000 at the end of three years.

b. Preferred stock was purchased at its par value of $54,000. The stock paid a 6% dividend (based on par value) each year for three years. At the end of three years, the stock was sold for $39,000.

c. Bonds were purchased at a cost of $70,000. The bonds paid annual interest of $1,500. After three years, the bonds were sold for $86,000.

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 11% return, and he gave Linda the following computations to support his statement:

   

Common stock:
Gain on sale ($161,000 – $99,000)	$	62,000
Preferred stock:
Dividends paid (6% × $54,000 × 3 years)		9,720
Loss on sale ($39,000 – $54,000)		(15,000	)
Bonds:
Interest paid ($1,500 × 3 years)		4,500
Gain on sale ($86,000 – $70,000)		16,000
Net gain on all investments	$	77,220

$77,220 ÷ 3 years	= 11.50 %
$223,000

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 11% discount rate, compute the net present value of each of the three investments.

1-b. On which investment(s) did Linda earn a 11% rate of return?

2. Considering all three investments together, did Linda earn a 11% rate of return?

3. Linda wants to use the $286,000 proceeds ($161,000 + $39,000 + $86,000 = $286,000) from sale of the securities to open a retail store under a 11-year franchise contract. What minimum annual net cash inflow must the store generate for Linda to earn a 10% return over the 11-year period?

Answer 1

1.b

2. NO

3.