Daryl Kearns saved $290,000 during the 25 years that he worked for a major corpo
ID: 2429991 • Letter: D
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:
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 B:
Compute the payback period for each opportunity. Which should Mr. Kearns adopt based on the payback approach?
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 14,500Explanation / Answer
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
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