Kathy Myers frequently purchases stocks and bonds, but she is uncertain how to determine the rate of return that she is earning.

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 $19,000 for 930 shares of Malti Company’s common stock. She received a $735 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 $22,000. Kathy would like to earn a return of at least 17% on all of her investments. She is not sure whether the Malti Company stock provided a 17% return and would like some help with the necessary computations.

Required:

1. Compute the net present value that Kathy earned on her investment in Malti Company stock. 

2. Did the Malti Company stock provide a 17% return?

Explanation

1.

	Now			Years 1-3		Year 3
Purchase of stock	$	(19,000	)
Annual cash dividend				$	735
Sale of stock						$	22,000
Total cash flows (a)	$	(19,000	)	$	735	$	22,000
Discount factor (17%) (b)		1.000			2.210		0.624
Present value (a) × (b)	$	(19,000	)	$	1,624	$	13,728
Net present value	$	(3,648	)

2.

No, Kathy did not earn a 17% return on the Malti Company stock. The negative net present value indicates that the rate of return on the investment is less than the minimum required rate of return of 17%.

Thanks