Internal rate of return Peace of Mind, Inc. (PMI), sells extended warranties for

ID: 2423873 • Letter: I

Question

Internal rate of return Peace of Mind, Inc. (PMI), sells extended warranties for durable

consumer goods such as washing machines and refrigerators. When PMI sells an extended

warranty, it receives cash up front from the customer, but later PMI must cover any repair

costs that arise. An analyst working for PMI is considering a warranty for a new line

of big-screen TVs. A consumer who purchases the 2-year warranty will pay PMI $200.

On average, the repair costs that PMI must cover will average $106 for each of the warranty’s

2 years. If PMI has a cost of capital of 7%, should it offer this warranty for sale?

PMI recieve from customer for warranty = $200

Average Repair cost = $106

cost of capital = 7%

Net present value from warranty offered = present value of cash inflow - present value of cash outflow

= $200 - ($106*1.808)

= $8.352

YES, PMI should offer this warranty for sale

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