Question

Daryl Kearns saved $240,000 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 $187,500. The following table presents the estimated cash inflows for the two alternatives:

  

	Year 1			Year 2			Year 3			Year 4
Opportunity #1	$	55,695		$	58,840		$	78,880		$	101,290
Opportunity #2		103,100			109,550			18,300			15,700

Mr. Kearns decides to use his past average return on mutual fund investments as the discount rate; it is 8 percent.

Required

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

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

Answer 1