Kathy Myers frequently purchases stocks and bonds, but she is uncertain how to d
ID: 2347879 • Letter: K
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, six years ago she paid $29,000 for 900 shares of Malti Company's common stock. She received a $630 cash dividend on the stock at the end of each year for six years. At the end of six years, she sold the stock for $22,800. Kathy would like to earn a return of at least 15% on all of her investments. She is not sure whether the Malti Company stock provided a 15% return and would like some help with the necessary computations. (Ignore income taxes.)
To determine the appropriate discount factor(s) using tables, click here to view Exhibit 12B-1 and Exhibit 12B-2. Alternatively, if you calculate the discount factor(s) using a formula, round to three (3) decimal places before using the factor in the problem.
Determine the net present value.
Explanation / Answer
The present value of the dividends payment is calculated using the Present Value of an Annuity table. Find the intersection of 12% and 5 years. On my table that value is 3.605 3.605 X $704 = $2,537.92 Te Present value of the price she received at the end of the 5 years is calculated using the Present Value of a Lump Sum table. Again find the intersection of 12% and 5 years. On my table that is 0.5674 0.5674 X $22,600 = $12,823.24 $12,823.24 + $2,537.92 = $15,361.16 NPV = $15,361.16 - $19,000 = (3,638.84) Since the NPV is a negative number, she earned much less than 12% on this investment. For Extra Credit Calculate the actual IRR on the investment. I used the RATE function in Excel, but you can use the tables as well. Using the PV of a Lump Sum table, the factor at 5 years at 7% is .7130 Using the PV of an Annuity table, the factor at 5 years at 7% is 4.100 (4.100 X $704) + ($22,600 X .7130) = $2,886 + $16,114 = $19,000 So you can see that the actual rate of return earned is only 7%
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