Question

Kathy Myers frequently purchases stocks and bonds, but she is uncertain how to determine the rate of return that she is earning. For example, three years ago she paid $13,000 for 200 shares of Malti Company’s common stock. She received a $420 cash dividend on the stock at the end of each year for three years. At the end of three years, she sold the stock for $16,000. Kathy would like to earn a return of at least 14% on all of her investments. She is not sure whether the Malti Company stock provide a 14% return and would like some help with the necessary computations.

Answer 1

(A) The net present value is -$1,225. (B) Kathy Myers did not earn 14% return on investment.

Step-by-step explanation:

Solution

(A) Calculate the net present value as shown below:

Now 1 2 3

Purchase of stock = ($13,000)

Annual Cash Divided $420 $420 $420

the Sale of Stock $16,000

Total cash Flow ($13,000) $420 $420 $420

Discount Factor at 14% 1.000 0.877 0.769 0.675

The present value ($13,000) $368 $323 $11,083

Net present value

($368 +$323 + $11,083- 13,000 = ($1,225)

The net present value is -$1,225.

(b) The NPV is negative. It shows that the rate of return on income is lower than the minimum required rate of return. so, KM did not earn 14% return.