Linda Clark received $210,000 from her mother\'s estate. She placed the funds in

Question

Linda Clark received $210,000 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 $98,000. 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 $53,000. 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 12% return, and he gave Linda the following computations to support his statement: Common stock Gain on sale ($160,000 $98,000) $ 62,000 Preferred stock: Dividends paid (6% x $53,000 x 3 years) Loss on sale ($39,000 $53,000) 9,540 (14,000) Bonds Interest paid ($1,500 x 3 years) Gain on sale ($86,000 $70,000) 4,500 16,000 Net gain on all investments $ 78,040 $78,040 +3years $210,000 =12.4%

Explanation / Answer

Solution

Particulars 0 1 2 3 a. Common Stock Purchase of stock (98000) 0 0 0 Sale of stock 0 0 0 160000 Total CAsh Flow (98000) 0 0 160000 Discount Factor 1 0.893 0.797 0.712 Present Value (98000) 0 0 113920 Net Present Value 15920 b. Preferred Stock : Purchase of stock (53000) 0 0 0 Annual Cash Dividend 0 3180 3180 3180 Sale of Stock 0 0 0 39000 Total Cash Flows (53000) 3180 3180 42180 Discount Factor 1 0.893 0.797 0.712 Present Value (53000) 2840 2534 30032 Net Present Value -17594 c. Bonds Purchase of bonds -70000 0 0 0 Annula Interest income 0 1500 1500 1500 Sale of bonds 0 0 0 86000 Total Cash Flows -70000 1500 1500 87500 Discount Factor 1 0.893 0.797 0.712 Present Value -70000 1340 1196 62300 Net Present Value -5164

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