higher interest reates are better for cYour bank account pays an interest rate of 8 percent. You are considering buying a share of stock in XYZ Corporation for $110. After 1, 2, and 3 years, it will pay a dividend of $5. You expect to sell the stock after 3 years for $120.

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Business

Guillermo Murray

18 May, 22:21

higher interest reates are better for cYour bank account pays an interest rate of 8 percent. You are considering buying a share of stock in XYZ Corporation for $110. After 1, 2, and 3 years, it will pay a dividend of $5. You expect to sell the stock after 3 years for $120.

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Jovan · Answer 1

This is a bad investment because you will lose money. NPV of the investment = - $1.85

Explanation:

You need to calculate the net present value of the stock using your bank's interest rate as your own discount rate (8%). The cash flows should be as follows.

year cash flow

0 - 110

1 5

2 5

3 125

We can calculate this using an excel spreadsheet but since the number of years is small, we can also do it manually:

NPV = - 110 + 5/1.08 + 5/1.08² + 125/1.08³ = - 110 + 4.63 + 4.29 + 99.23 = - 110 + 108.15 = - $1.85