Daryl Kearns saved $270,000 during the 25 years that he worked for a major corpo
ID: 2546951 • Letter: D
Question
Daryl Kearns saved $270,000 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 $191,000. 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 10 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?
Year 1 Year 2 Year 3 Year 4 Opportunity #1 $ 55,715 $ 58,910 $ 78,750 $ 101,400 Opportunity #2 103,100 109,350 17,500 14,900 Required ARequired 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.) Net Present Value Opportunity 1 Opportunity 2 Which opportunity should be chosen?Explanation / Answer
Opportunity # 1
Net present value = Present value of cash inflows - Present value of cash outflows
= 227,702.05 - 191,000
= 36,702.05
Opportunity # 2
Net present value = Present value of cash inflows - Present value of cash outflows
= 207,360.2 - 191,000
= 16,360.2
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Opportunity # 1
Pay back period = 2 years + (191,000 - 114,625) / (193,375 - 114,625)
= 2 + (76,375 / 78,750)
= 2.97 years
Opportunity # 2
Pay back period = 1 year + (191,000 - 103,100) / (212,450 - 103,100)
= 1 + (87,900 / 109,350)
= 1.8 years
Cash inflows PVAF@10% Present value of cash inflows Year 1 55,715 0.909 50,644.94 Year 2 58,910 0.826 48,659.66 Year 3 78,750 0.751 59,141.25 Year 4 101,400 0.683 69,256.2 227,702.05Related Questions
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