2. Cash flow calculations and net present value On January 2, 20X1, Bruce Greene
ID: 2459108 • Letter: 2
Question
2. Cash flow calculations and net present value
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
Answer 1. Chronological List of Investment Cash Flows Date Particulars Amount Cash outflow Jan 2, 20X1 Purchase of 500 shares of Heartland Dev. $10,000 Cash Inflow 20X1 Div. recd ($2.60 X 500 shares) $1,300 20X2 Div. recd ($2.60 X 500 shares) $1,300 20X3 Div. recd ($3.10 X 500 shares) $1,550 Dec 31, 20X3 Sale of 500 shares of Heartland Dev. $13,000 Answer 2. Calculation of NPV Date Particulars Year Amt. (A) PV Vale of annuity @16% (B) FV (A X B) Cash Inflow 20X1 Div. recd ($2.60 X 500 shares) 1 $1,300 0.8621 $1,121 20X2 Div. recd ($2.60 X 500 shares) 2 $1,300 0.7432 $966 20X3 Div. recd ($3.10 X 500 shares) 3 $1,550 0.6407 $993 Dec 31, 20X3 Sale of 500 shares of Heartland Dev. 3 $13,000 0.6407 $8,329 c. Total Cash Inflow $11,409 Cash Outflow Jan 2, 20X1 Purchase of 500 shares of Heartland Dev. 0 $10,000 1 $10,000 D. Total Cash Outflow $10,000 NPV (C-D) $1,409 Answer 3. As the NPV is $1409, the Bruce Green should invest in the shares of Heartland Development Inc, as he is getting the return more than 16%.
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