Linda Clark received $175,000 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 $95,000. 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 $30,000. 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 $27,000.

c. Bonds were purchased at a cost of $50,000. The bonds paid annual interest of $6,000. After three years, the bonds were sold for $52,700.

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 16% return, and he gave Linda the following computations to support his statement:

Required:

1. Using a 16% discount rate, compute the net present value of each of the three investments. On which investment(s) did Linda earn a 16% rate of return? (Round computations to the nearest whole dollar.)

2. Considering all three investments together, did Linda earn a 16% rate of return? Explain.

3. Linda wants to use the $239,700 proceeds ($160,000 + $27,000 + $52,700 = $239,700) from sale of the securities to open a retail store under a 12-year franchise contract. What minimum annual net cash inflow must the store generate for Linda to earn a 14% return over the 12-year period? Round computations to the nearest whole dollar.

Transcribed Image Text:

Common stock: Gain on sale ($160,000 – $95,000).. $65,000 Preferred stock: Dividends paid (6% x $30,000 x 3 years) Loss on sale ($27,000 – $30,000) ... 5,400 (3,000) Bonds: Interest paid ($6,000 x 3 years) Gain on sale ($52,700 – $50,000) 18,000 2,700 Net gain on all investments $88,100 $88,100 ÷ 3 years = 16.8% $175,000