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 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

Answer 1.
Year	0	1	2	3	4
Investment 1
Cash Inflow	(160,000)	44,000	47,200	63,200	80,000
PV Factor - 8%	1.00000	0.92593	0.85734	0.79383	0.73503
Present Value	(160,000)	40,741	40,466	50,170	58,802
NPV	30,180
Investment 2
Cash Inflow	(160,000)	81,600	86,400	16,000	16,000
PV Factor - 12%	1.00000	0.92593	0.85734	0.79383	0.73503
Present Value	(160,000)	75,556	74,074	12,701	11,760
NPV	14,092
Investment 1- Highest NPV
Answer 2.
Payback period - Investment 1
Year	Intial Invetments	Cash Inflow	Accumulated Net Cash Inflow
0	160,000	-	-
1		44,000	44,000
2		47,200	91,200
3		63,200	154,400
4		80,000	234,400
Payback period = 3 Years + (5,600 / 80,000 x 1 Year)
Payback period = 3 Years + 0.07
Payback period = 3.07 Years (Approx.)
Payback period - Investment 2
Year	Intial Invetments	Cash Inflow	Accumulated Net Cash Inflow
0	160,000	-	-
1		81,600	81,600
2		86,400	168,000
3		16,000	184,000
4		16,000	200,000
Payback period = 1 Years + (78,400 / 86,400 x 1 Year)
Payback period = 1 Years + 0.91
Payback period = 1.91 Years (Approx.)
Investment 2- Lower Payback Period