Question

Daryl Kearns saved $280,000 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 $190,000. The following table presents the estimated cash Inflows for the two alternatives Year 1 Year 2 Year 3 Year 4 $78,780 $ 55,710 Opportunity #1 S58,940 109,450 $101, 390 14,600 Opportunity #2 103,40e 18,100 Mr. Kearns decides to use his past average retuun on mutual fund Investments as the discount rate, It is 9 percent. PV of $1 and PVA of $1) (Use approprlate factor(s) from the tables provided.) Required a. Compute the net present value of each opportunity Which should Mr. Kearns adopt based on the net present value approach? b. Compute the payback period for each opportunity. Which should Mr Kearns adopt based on the payback approach? ces

Answer 1

rate positively ..

Req a)
	Computation of NPV
		i	ii	iii	iv=i*iii	v=ii*iii
	year	Cash flow oppt 1	Cash flow oppt 2	PVIF @ 9%	PV oppt 1	PV oppt 2
	0	-190000	-190000	1.0000	(190,000.00)	(190,000.00)
	1	55710	103400	0.9174	51,110.09	94,862.39
	2	58940	109450	0.8417	49,608.62	92,121.88
	3	78780	18100	0.7722	60,832.61	13,976.52
	4	101390	14600	0.7084	71,827.23	10,343.01
					43,378.56	21,303.79
	NPV oppt -1 =		43,378.56
	NPV oppt -2 =		21,303.79
	firm should choose oppt 1 because it has higher NPV
Req b)	Computation of payback period
		i	ii
	year	Cash flow oppt 1	Cash flow oppt 2	cumulative cash flow oppt -1	cumulative cash flow oppt -2
	0	-190000	-190000	(190,000)	(190,000)
	1	55710	103400	(134,290)	(86,600)
	2	58940	109450	(75,350)	22,850
	3	78780	18100	3,430	40,950
	4	101390	14600	104,820	55,550
	Payback period oppt 1 =		2+75350/78780	2.96	year
	Payback period oppt 2 =		1+86600/109450	1.79	year
	As per payback period oppt 2 should be selected. Because it has lower payback period.