Question

Daryl Kearns saved $290,000 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 $188,500. The following table presents the estimated cash inflows for the two alternatives:

  

    Year 1   Year 2   Year 3   Year 4
Opportunity #1   $   55,660      $   58,790      $   78,790      $   101,300     
Opportunity #2      103,100         109,700         17,000         14,500     
  

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?

Answer 1

Opportunity 1 @ 12 Cummulative PV PV of Cash inflows PV Factor Cash inflows Cash inflows 0.8929 0.7972 0.7118 0.6355 Year 55660 58790 78790 101300 49699 46867 49699 96566 1 2 152649 217025 56083 64376 4 217025 -188500 Initial investment Net prasent value 28525 3.56 Years Paybackperiod > Payback period 3 years + ( ( 188500 - 152649 ) / 64376 = 3.56 years

Opportunity #2 @ 12 Cummulative PV PV of Cash inflows PV Factor Cash inflows Cash inflows 0.8929 0.7972 0.7118 0.6355 Year 92058 87453 12101 9215 92058 179511 103100 109700 17000 14500 1 2 191611 200826 4 200826 -188500 Initial investment 12326 Net prasent value Paybackperiod = 2.74 Years Payback period 2 years ( 183500 - 179511) 12101 2.74 years

Net Present Value 1) Particulars Opportunity 1 Opportunity #2 Select 28525 12326 Opportunity 1 Payback period 2) Particulars Opportunity 1 Opportunity #2 Select 3.56 Years 2.74 Years Opportunity #2