Exercise 12-7 Basic Net Present Value Analysis [LO1] Kathy Myers frequently purc

Question

Exercise 12-7 Basic Net Present Value Analysis [LO1]

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 $22,000 for 930 shares of Malti Company's common stock. She received a $651 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 13% on all of her investments. She is not sure whether the Malti Company stock provided a 13% return and would like some help with the necessary computations. (Ignore income taxes.)

Determine the net present value.

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 $22,000 for 930 shares of Malti Company's common stock. She received a $651 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 13% on all of her investments. She is not sure whether the Malti Company stock provided a 13% return and would like some help with the necessary computations. (Ignore income taxes.)

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%

Related Questions

Navigate

• Browse (All)
• Browse E
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.