Question

Daryl Kearns saved $270,000 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 $182,500. The following table presents the estimated cash inflows for the two alternatives:

  

	Year 1			Year 2			Year 3			Year 4
Opportunity #1	$	55,645		$	58,750		$	78,810		$	101,300
Opportunity #2		103,300			109,100			18,000			15,600

  

Mr. Kearns decides to use his past average return on mutual fund investments as the discount rate; it is 10 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?

Answer 1

Mr. Kearns adopt opportunity 1 because the NPV of Opportunity 1 is better that Opportunity 2

Mr. Kearns adopt Opportunity 2 because the payback period is better that opportunity 1