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 $183,500. The following table presents the estimated cash inflows for the two alternatives:

  

	Year 1			Year 2			Year 3			Year 4
Opportunity #1	$	55,635		$	58,950		$	78,880		$	101,380
Opportunity #2		102,800			109,450			16,800			14,500

  

Mr. Kearns decides to use his past average return on mutual fund investments as the discount rate; it is 9 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?

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.)

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

Requiered 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

		Present Value (PV) of Cash Flow:
		(Cash Flow)/((1+i)^N)
		i=Discount Rate
		N=Year of Cash Flow
		i=9%=	0.09
		OPPORTUNITY #1
	N	Year	0	1	2	3	4
	A	Cash flow	($183,500)	$55,635	$58,950	$78,880	$101,380
	B	Cumulative Cash Flow	($183,500)	($127,865)	($68,915)	$9,965	$111,345	SUM
	C=A/(1.09^N)	PV of Cash Flow	$       (183,500)	$    51,041	$ 49,617	$ 60,910	$ 71,820	$ 49,888
		Net Present Value(NPV)=	Sum of PV of cash flows
		Net Present Value(NPV)=	$            49,888
		Payback Period=	Period at which cumulative cash flow is NIL
		Payback period in years	2.87	(2+(68915/78880)
		OPPORTUNITY #2
	N	Year	0	1	2	3	4
	A	Cash flow	($183,500)	$102,800	$109,450	$16,800	$14,500
	B	Cumulative Cash Flow	($183,500)	($80,700)	$28,750	$45,550	$60,050	SUM
	C=A/(1.09^N)	PV of Cash Flow	$       (183,500)	$    94,312	$ 92,122	$ 12,973	$ 10,272	$ 26,179
		Net Present Value(NPV)=	Sum of PV of cash flows
		Net Present Value(NPV)=	$            26,179
		Payback Period=	Period at which cumulative cash flow is NIL
		Payback period in years	1.74	(1+(80700/109450)
	Requiered A:
			Net Present Value
		Opportunity 1	$            49,888
		Opportunity 2	$            26,179
		Which opportunity should be chosen?	Opportunity#1
		Required B
			Payback Period
		Opportunity 1	2.87
		Opportunity 2	1.74
		Which opportunity should be chosen?	Opportunity#2