Question

Daryl Kearns saved $240,000 during the 30 years that he worked for a major corporation. Now he has retired at the age of 60 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 $160,000. The following table presents the estimated cash inflows for the two alternatives:

	Year 1			Year 2			Year 3			Year 4
Opportunity #1	$	44,000		$	47,200		$	63,200		$	80,000
Opportunity #2		81,600			86,400			16,000			16,000

Mr. Kearns decides to use his past average return on mutual fund investments as the discount rate; it is 8 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.)

Required

1. Compute the net present value of each opportunity. Which should Mr. Kearns adopt based on the net present value approach?

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

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

• 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?

• Required B

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

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

Answer 1

Requirement-a:

Calculation of Net Present Value of Opportunity 1 (Amounts in $)

Year	Cash Inflows (i)	PVF @ 8% (ii)	PV of Cash Inflows (i*ii)
1	44,000	0.92593	40,740.92
2	47,200	0.85734	40,466.45
3	63,200	0.79383	50,170.06
4	80,000	0.73503	58,802.40
Present Value of Cash Inflows	190,179.83
Less: Initial Investment	160,000.00
Net Present Value	30,179.83

Therefore the net present value of opportunity 1 is $30,179.83.

Calculation of Net Present Value of Opportunity 2 (Amounts in $)

Year	Cash Inflows (i)	PVF @ 8% (ii)	PV of Cash Inflows (i*ii)
1	81,600	0.92593	75,555.89
2	86,400	0.85734	74,074.18
3	16,000	0.79383	12,701.28
4	16,000	0.73503	11,760.48
Present Value of Cash Inflows	174,091.83
Less: Initial Investment	160,000.00
Net Present Value	14,091.83

Therefore the net present value of opportunity 2 is $14,091.83.

As the net present value of opportunity 1 is higher than the second one, thus, Daryl Kearns should chose opportunity 1.

Requirement-b:

Calculation of Payback Period for Opportunity 1 (Amounts in $)

Year	Cash Inflows	Cumulative Cash Inflows
1	44,000	44,000
2	47,200	91,200
3	63,200	154,400
4	80,000	234,400

Payback period = 3 yrs + [(160,000-154,400)/80,000]

= 3 yrs + 0.07

= 3.07 years

Calculation of Payback Period for Opportunity 2 (Amounts in $)

Year	Cash Inflows	Cumulative Cash Inflows
1	81,600	81,600
2	86,400	168,000
3	16,000	184,000
4	16,000	200,000

Payback period = 1 yr + [(160,000-81,600)/86,400]

= 1 yr + 0.91

= 1.91 years

As the payback period is shorter for opportunity 2, Daryl Kearns should chose opportunity 2.

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