On January 2, 20X1, Bruce Greene invested $10,000 in the stock market and purcha

Question

On January 2, 20X1, Bruce Greene invested $10,000 in the stock market and purchased 500 shares of Heartland Development, Inc. Heartland paid cash dividends of $2.60 per share in 20X1 and 20X2; the dividend was raised to $3.10 per share in 20X3. On December 31, 20X3, Greene sold his holdings and generated proceeds of $13,000. Greene uses the net-present- value method and desires a 16% return on investments.

a.       Prepare a chronological list of the investment's cash flows. Note: Greene is entitled to the 20X3 dividend.

b.      Compute the investment's net present value, rounding calculations to the nearest dollar.

c.       Given the results of part (b), should Greene have acquired the Heartland stock? Briefly explain.

Explanation / Answer

a) Chronological list of Investment's cash flows Date Cash flows Description Jan 2, 20x1 ($10,000) This is cash outflow and hence shown negative. Dec 31, 20x1 $1,300 Cash inflow, hence shown positive. (500 shares*$2.60 per share) Dec 31, 20x2 $1,300 Cash inflow, hence shown positive. (500 shares*$2.60 per share) Dec 31, 20x3 $1,550 Cash inflow, hence shown positive. (500 shares*$3.10 per share) Dec 31, 20x3 $13,000 Cash inflow, sale proceeds. b) Computation of investment's Net present value Year PV factor Cash PV of at 16% flows cash flows 0 1.00000 ($10,000) ($10,000) 1 0.86207 $1,300 $1,121 2 0.74316 $1,300 $966 3 0.64066 $14,550 $9,322 Net Present value = $1,408 Notes: Year 3 cash flows include $1550 dividend receipt + $13000 sale proceeds = $14,550. PV factor at 16% has been calculated as 1/(1+.16)^1 for Year 1, 1/(1+.16)^2 for year 2 and so on%u2026 PV of cash flows = PV factor at 16% * Cash flows c) YES. Greene should have acquired the Heartland's stock. This is because the NPV at 16% required return works out positive. A positive NPV means that the investor is earning above the minimum required return of 16%. Decision criteria for NPV: If NPV >0 , accept the investment and If NPV

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