Jessica Nekton received $150,000 from her mother\'s estate. She placed the funds

Question

Jessica Nekton received $150,000 from her mother's estate. She placed the funds into the hands of a broker, who purchased the following securities on Ms. Nekton's behalf a. Common stock was purchased at a cost of S75,000. The stock paid no dividends, but it was sold for $170,000 at the end of six years b. Preferred stock was purchased at its par value of $47,000. The stock paid a 8% dividend (based on par value) each year for six years. At the end of six years, the stock was sold for $33,000 c. Bonds were purchased at a cost of $28,000. The bonds paid $1,000 in interest every six months. After six years, the bonds were sold for $35,000. (Note: In discounting a cash flow that occurs semiannually the procedure is to halve the discount rate and double the number of periods. Use the same procedure in discounting the proceeds from the sale.) (Ignore income taxes.) The securities were all sold at the end of six years so that Ms. Nekton would have funds available to start a new business venture. The broker stated that the investments had earned more than a 12% return, and he gave Ms. Nekton the following computation to support his statement: Common stock 95,000 22,560 (14,000) 12,000 7,000 Gain on sale ($170,000 $75,000) Preferred stock Dividends paid (8% x $47,000 x 6 years) Loss on sale ($33,000 $47,000) Bonds Interest paid ($1,000 × 12 periods) Gain on sale (S35,000 $28,000) Net gain on all investments $122,560 $122.560 ÷6years $150,000 -13.6% Click here to view Exhibit 11B-1 and Exhibit 11B-2, to determine the appropriate discount factor(s) using tables

Explanation / Answer

1a)

Net present value of common stock = 170000*PVIF(12%,6) - 75000 = 170000*0.5066 - 75000 = 86122-75000 = 11122

Net present value of preferred stock = 47000*8%*PVAF(12%,6) + 33000*PVIF(12%,6) - 47000 = 3760*4.111 + 33000*0.5066 - 47000 = 15457.36 + 16717.80 - 47000 = -14825

Net present value of Bond = 1000*PVAF(6%,12) + 35000*PVIF(6%,12) - 28000 = 1000*8.3838 + 35000*0.4969 - 28000 = 8383.80 + 17391.50 - 28000 = -2225

1b)

Common Stock

2.

No

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