Question

Daryl Kearns saved $260,000 during the 25 years that he worked for a major corporation. Now he has retired at the age of 50 and has begun to draw a comfortable pension check every month. He wants to ensure the financial security of his retirement by investing his savings wisely and is currently considering two investment opportunities. Both investments require an initial payment of $186,000. The following table presents the estimated cash inflows for the two alternatives: Year 1 Year 2 Year 3 Year 4 Opportunity #1 $ 55,715 $ 58,750 $ 78,860 $ 101,380 Opportunity #2 103,500 109,350 18,000 15,600 Mr. Kearns decides to use his past average return on mutual fund investments as the discount rate; it is 12 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.) Required Compute the net present value of each opportunity. Which should Mr. Kearns adopt based on the net present value approach? Compute the payback period for each opportunity. Which should Mr. Kearns adopt based on the payback approach?

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• Required A
• Required B

Compute the net present value of each opportunity. Which should Mr. Kearns adopt based on the net present value approach? (Round your intermediate calculations and final answer to two decimal places.)

	Net Present Value Opportunity 1 Opportunity 2 Which opportunity should be chosen?

Complete this question by entering your answers in the tabs below.

• Required A
• Required B

Compute the payback period for each opportunity. Which should Mr. Kearns adopt based on the payback approach?

	Payback Period Opportunity 1 Opportunity 2 Which opportunity should be chosen?

Answer 1

x B4 А C D E F G Н I J K L 1 Opportunity #2 Opportunity #1 2 present value present value of present value present value of cumulative year cumulative cash cash flows cash flows cash flows factor @ 12% factor @ 12% cash flows cash flows flows -$186,000 $55,715 $58,750 -$186,000.00 -$186,000 -$186,000 $1.00 -$186,000.00 -$186,000 4 0 1 -$ 82,500 $ 26,850 $49,745.69 -$130,285 $103,500 $109,350 $0.89 $92,411.01 5 1 0.89286 $46,834.91 -$71,535 $0.80 $87,172.73 6 2. 0.79719 $7,325 $18,000 $78,860 0.71178 $56,130.97 $0.71 $12,812.04 $44,850 7 3 $101,380 $64,429.02 $108,705 $15,600 $0.64 $9,914.11 $60,450 8 4 0.63552 $16,309.89 $31,140.59 9 10 Net Present Value Payback Period 11 $31,140.59 2.91 Opportunity 1 Opportunity 1 years 12 $16,309.89 Opportunity 2 1.75 Opportunity 2 years 13 Opportunity 1 reason because Opportunity 1 has higher net present value Which opportunity should be chosen? Which opportunity should be chosen? Opportunity 2 14 reason because Opportunity 2 has lower payback period 15 16

for formulas and calculations, refer to the image below -

В4 0 B A C E G H I 1 Opportunity #1 Opportunity #2 2 present value of cumulative cash cumulative year cash flows present value factor @ 12% cash flows present value factor @ 12% present value of cash cash flows cash flows flows flows 3 =ROUND(-PV(12%,B4,0,1),5)ROUND(G4*H4,2) =ROUND( -PV(12%, B5,0,1),5) ROUND(G5*H5,2) =ROUND(-PV(12%, B6,0, 1) ,5) ROUND(G6*H6,2) -ROUND(-PV(12%,B7,0,1),5) =ROUND(G7*H7,2) =ROUND( -PV(12%, B8,0,1),5) ROUND(G8*H8,2) -SUM(14:18) =ROUND(-PV(12%, B4,0, 1) ,5) ROUND(C4*D4,2) -ROUND (-PV(12%, B5,0,1),5)ROUND (C5*D5,2) -ROUND(-PV(12%,B6,0,1),5) =ROUND(C6* D6, 2) =ROUND(-PV(12%,B7,0,1),5) ROUND(C7*D7,2) =ROUND(-PV(12%,B8,0,1),5) ROUND(C8*D8,2) -SUM(E4:E8) -C4 -186000 4 0 G4 -186000 -F4+C5 -F5+C6 103500 109350 J4+G5 EJ5+G6 55715 58750 5 1 6 78860 101380 =J6+G7 EJ7+G8 F6+C7 18000 7 3 15600 4 F7+C8 8 9 10 Payback Period 11 Net Present Value =2+(-F6 /C7) 1+ (- J5 /G6) Opportunity 2 E9 19 Opportunity 1 Opportunity 1 years 12 Opportunity 2 Opportunity 2 years 13 Opportunity 1 Which opportunity should be chosen? Which opportunity should be chosen? 14 reason because Opportunity 1 has higher net present value reason because Opportunity 2 has lower payback period 15 16

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