Daryl Kearns saved $240,000 during the 30 years that he worked for a major corpo
ID: 2575649 • Letter: D
Question
Daryl Kearns saved $240,000 during the 30 years that he worked for a major corporation. Now he has retired at the age of 60 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 $160,000. 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 8 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 $ 44,000 $ 47,200 $ 63,200 $ 80,000 Opportunity #2 81,600 86,400 16,000 16,000Explanation / Answer
We need to find the PV of cash inflow of both investment opportunity.
PV of opportunity = PV of cash inflow – initial cash outflow
The opportunity with higher PV will ne selected.
Year
Investment 1
Investment 2
PV factor @ 8%
PV of invs 1
PV of invs 2
1
44000
81600
0.92593
40740.74
75555.56
2
47200
86400
0.85734
40466.39
74074.07
3
63200
16000
0.79383
50170.20
12701.32
4
80000
16000
0.73503
58802.39
11760.48
Total
190179.72
174091.42
Initial outflow
160000
160000.00
PV
30179.72
14091.42
Opportunity 1 has higher PV (30179.72), so it should be selected.
Year
Investment 1
Investment 2
PV factor @ 8%
PV of invs 1
PV of invs 2
1
44000
81600
0.92593
40740.74
75555.56
2
47200
86400
0.85734
40466.39
74074.07
3
63200
16000
0.79383
50170.20
12701.32
4
80000
16000
0.73503
58802.39
11760.48
Total
190179.72
174091.42
Initial outflow
160000
160000.00
PV
30179.72
14091.42
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