Daryl Kearns saved $240,000 during the 25 years that he worked for a major corpo

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 $187,000. 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 9 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.)

  

Required

a) Compute the net present value of each opportunity.

b) Compute the payback period for each opportunity.

Year 1 Year 2 Year 3 Year 4 Opportunity #1 $ 55,710 $ 58,840 $ 78,850 $ 101,400 Opportunity #2 102,800 109,200 17,900 14,700 TABLE 1 PRESENT VALUE OF $1 4% 5% 6% 1% 8% 9% 10% 12% 14% 16% 20% 1 0.961538 0.952381 0.943396 0.934579 0.925926 0.917431 0.909091 0.892857 0.877193 0.862069 0.833333 2 0.924556 0.907029 0.889996 0.873439 0.857339 0.841680 0.826446 0.797194 0.769468 0.743163 0.694444 3 0.888996 0.863838 0.839619 0.816298 0.793832 0.772183 0.751315 0.711780 0.674972 0.640658 0.578704 4 0.854804 0.822702 0.792094 0.762895 0.735030 0.708425 0.683013 0.635518 0.592080 0.552291 0.482253 5 0.821927 0.783526 0.747258 0.712986 0.680583 0.649931 0.620921 0.567427 0.519369 0.476113 0.401878 6 0.790315 0.746215 0.704961 0.666342 0.630170 0.596267 0.564474 0.506631 0.455587 0.410442 0.334898 7 0.759918 0.710681 0.665057 0.622750 0.583490 0.547034 0.513158 0.452349 0.399637 0.353830 0.279082 8 0.730690 0.676839 0.627412 0.582009 0.540269 0.501866 0.466507 0.403883 0.350559 0.305025 0.232568 9 0.702587 0.644609 0.591898 0.543934 0.500249 0.460428 0.424098 0.36061O 0.307508 0.262953 0.193807 10 0.675564 0.613913 0.558395 0.508349 0.463193 0.422411 0.385543 0.321973 0.269744 0.226684 0.161506 11 0.649581 0.584679 0.526788 0.475093 0.428883 0.387533 0.350494 0.287476 0.2366170.195417 0.134588 12 0.624597 0.556837 0.496969 0.444012 0.397114 0.355535 0.318631 0.256675 0.207559 0.168463 0.112157 13 0.600574 0.530321 0.468839 0.414964 0.367698 0.326179 0.289664 0.229174 0.182069 0.145227 0.093464 14 0.577475 0.505068 0.442301 0.387817 0.340461 0.299246 0.263331 0.204620 0.159710 0.125195 0.077887 15 0.555265 0.481017 0.417265 0.362446 0.315242 0.274538 0.239392 0.182696 0.140096 0.107927 0.064905 16 0.533908 0.458112 0.393646 0.338735 0.291890 0.251870 0.217629 0.163122 0.122892 0.093041 0.054088 17 0.513373 0.436297 0.371364 0.316574 0.270269 0.231073 0.197845 0.145644 0.107800 0.080207 0.045073 18 0.493628 0.415521 0.350344 0.295864 0.250249 0.211994 0.179859 0.130040 0.094561 0.069144 0.037561 19 0.474642 0.395734 0.330513 0.276508 0.231712 0.194490 0.163508 0.116107 0.082948 0.059607 0.031301 20 0.456387 0.376889 0.311805 0.258419 0.214548 0.178431 0.148644 0.103667 0.072762 0.051385 0.026084

Explanation / Answer

Statement showing Cash flows Oppurtunity A Opputunity B Particulars Time PVf 9% Amount PV Cash Outflows                        -                              1.00               (187,000.00)               (187,000.00)               (187,000.00)               (187,000.00) PV of Cash outflows = PVCO               (187,000.00)               (187,000.00) Cash inflows                    1.00                  0.917431                    55,710.00                    51,110.08                  102,800.00                    94,311.91 Cash inflows                    2.00                  0.841680                    58,840.00                    49,524.45                  109,200.00                    91,911.46 Cash inflows                    3.00                  0.772183                    78,850.00                    60,886.63                    17,900.00                    13,822.08 Cash inflows                    4.00                  0.708425                  101,400.00                    71,834.30                    14,700.00                    10,413.85 PV of Cash Inflows =PVCI                  233,355.46                  210,459.29 NPV= PVCI - PVCO                    46,355.46                    23,459.29 PBP Oppurtunity A Oppurtunity B Time Amount Cumulative Amount Cumulative                                                                                       -      (187,000.00)            (187,000.00)               (187,000.00)               (187,000.00)                                                                                  1.00         55,710.00            (131,290.00)                  102,800.00                  (84,200.00)                                                                                  2.00         58,840.00               (72,450.00)                  109,200.00                    25,000.00                                                                                  3.00         78,850.00                   6,400.00                    17,900.00                    42,900.00                                                                                  4.00       101,400.00               107,800.00                    14,700.00                    57,600.00 Payback period 2 + 72450/78850 1 + 84200/109200 Payback period 2.92 Years approx 1.77 years approx Payback period

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