Question

Linda Clark received $170,000 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 $91,000. The stock paid no dividends, but it was sold for $160,000 at the end of three years.
b.	Preferred stock was purchased at its par value of $46,000. The stock paid a 4% dividend (based on par value) each year for three years. At the end of three years, the stock was sold for $32,000.
c.	Bonds were purchased at a cost of $73,000. The bonds paid annual interest of $3,500. After three years, the bonds were sold for $75,000.

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 14% return, and he gave Linda the following computations to support his statement

Common stock:
Gain on sale ($160,000 – $91,000)	$	69,000
Preferred stock:
Dividends paid (4% × $46,000 × 3 years)		5,520
Loss on sale ($32,000 – $46,000)		(14,000)
Bonds:
Interest paid ($3,500 × 3 years)		10,500
Gain on sale ($75,000 – $73,000)		2,000
Net gain on all investments	$	73,020

    

	$73,020 ÷ 3 years	= 14.3%
	$170,000

         

Click here to view Exhibit 11B-1 and Exhibit 11B-2, to determine the appropriate discount factor(s) using tables.

1-a. Using a 14% discount rate, compute the net present value of each of the three investments. (Any cash outflows should be indicated by a minus sign. Use the appropriate table to determine the discount factor(s).)

Item	Now	1	2	3
Common Stock:
Purchase of stock
Sale of the stock
Total cash flows
Discount factor
Present Value
Net Present Value
Preferred Stock:
Purchase of the stock
Annual cash dividend
Sale of the stock
Total cash flows
Discount factor
Present value
Net present value
Bonds:
Purchase of the bonds
Annual interest income
Sale of the bonds
Total cash flows
Discount factors
Present Value
Net Present Value

	1-b. On which investment(s) did Linda earn a 14% rate of return? (You may select more than one answer. Single click the box with a check mark for correct answers and double click to empty the box for the wrong answers.) Common stock Bonds Preferred stock 2. Considering all three investments together, did Linda earn a 14% rate of return? Yes No

Answer 1