Bruce Graham saved $250,000 during the 25 years that he worked for a major corpo

Question

Bruce Graham saved $250,000 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 cur- rently 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.

Mr. Graham decides to use his past average return on mutual fund investments as the dis- count rate; it is 8 percent.

Year 1 Year 2 Year 3 Year 4

Opportunity 1 55625 58750 78750 101250

Opportunity 2 102500 108750 17500 15000

Required

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

b. Compute the payback period for each project. Which should Mr. Graham adopt based on the payback approach?

c. Compare the net present value approach with the payback approach. Which method is bet- ter in the given circumstances?

Explanation / Answer

Opportunity 1 Years Inflow Factor PV of Inflow 1.00 55,625.00 0.93 51,504.63 2.00 58,750.00 0.86 50,368.66 3.00 78,750.00 0.79 62,514.29 4.00 101,250.00 0.74 74,421.77 Total Inflow 238,809.35 Less: initial Investment 187,500.00 NPV 51,309.35 Opportunity 2 Years Inflow Factor PV of Inflow 1.00 102,500.00 0.93 94,907.41 2.00 108,750.00 0.86 93,235.60 3.00 17,500.00 0.79 13,892.06 4.00 15,000.00 0.74 11,025.45 Total Inflow 213,060.52 Less: initial Investment 187,500.00 NPV 25,560.52 Please consider the time devoted to make this reply by rating this as 5 star. Thank u in advance. God bless u :)

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