[wei lun]

Section A
Lisa Springfield received $200,000 from her mother's estate. She placed the funds into the hands of a broker, who purchased the following securities on Lisa's behalf:

a. Common stock was purchased at a cost of $125,000. The stock paid no dividends, but it was sold for $208,000 at the end of three years.
b. Preferred stock was purchased at its par value of $45,000. The stock paid a 6% dividend (based on par value) each year for three years. At the end of three years, the stock was sold for $43,000.
c. Bonds were purchased at a cost of $30,000. The bonds paid $1,800 in interest every six months. After three years, the bonds were sold for $29,000. (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.)

The securities were all sold at the end of three years so that Lisa would have funds available to open a new business venture. The broker stated that the investments had earned more than a 16% return, and he gave Linda the following computation to support his statement:

Common stock:
Gain on sale ($208,000 – $125,000) $83,000
Preferred stock:
Dividends paid (6% × $45,000 × 3 years) 8,100
Loss on sale ($43,000 – $45,000) (2,000)
Bonds:
Interest paid ($1,800 × 6 periods) 10,800
Loss on sale ($29,000 – $30,000) (1,000)
Net gain on all investments $98,900

$98,900 ÷ 3 years = 16.5%
$200,000

Required:

1. Using a 16% discount rate, compute the net present value of each of the three investments. On which investment(s) did Lisa earn a 16% rate of return? (Round computations to the nearest whole dollar.) (20 marks)
2. Considering all three investments together, did Lisa earn a 16% rate of return? Explain.
(10 marks)
3. Lisa wants to use the $280,000 proceeds ($208,000 + $43,000 + $29,000 = $280,000) from sale of the securities to open a fast-food franchise under 10-year contract. What net annual cash inflow must the store generate for Lisa to earn a 14% return over the 10-year period? (Round computations to the nearest whole dollar.) (10 marks)


Section B
1. Critically evaluate the following three methods of investment appraisal with practical examples:
a) NPV
b) IRR
c) Payback Period Method (45 marks)

2. Discuss the relative merits of bonds and common stocks. Provide real life examples.
(15 marks)

[Curlyben]

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