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  • Bob and Lisa are both married, working adults. They both plan for retirement and consider the $2,000 annual contribution a must.

    First, consider Lisa’s savings. She began working at age 20 and began making an annual contribution of $2,000 at the first of the year beginning with her first year. She makes 13 contributions. She worked until she was 32 and then left full time work to have children and be a stay at home mom. She left her IRA invested and plans to begin drawing from her IRA when she is 65.

    Bob started his IRA at age 32. The first 12 years of his working career, he used his discretionary income to buy a home, upgrade the family cars, take vacations, and pursue his golfing hobby. At age 32, he made his first $2,000 contribution to an IRA, and contributed $2,000 every year up until age 65, a total of 33 years / contributions. He plans to retire at age 65 and make withdrawals from his IRA.

    Both IRA accounts grow at a 7% annual rate. Do not consider any tax effect.
  • Write two paragraphs summary in which you:
    • Create a chart summarizing the details of the investment for both Bob and Lisa.
    • Explain the results in terms of time value of money.
      • Required:
        Compare the results of the three (3) methods by quality of information for decision making. Using what you have learned about the three (3) methods, identify the best project by the criteria of long term increase in value. (You do not need to do further research.) Convey your understanding of the Time Value of Money principles used or not used in the three (3) methods. Review the video titled “NPV, IRR, MIRR for Mac and PC Excel” (located athttps://www.youtube.com/watch?v=C7CryVgFbBc and previously listed in Week 4) to help you understand the foundational concepts: 

        Scenario Information:
        Assume that two gas stations are for sale with the following cash flows; CF1 is the Cash Flow in the first year, and CF2 is the Cash Flow in the second year. This is the time line and data used in calculating the Payback Period, Net Present Value, and Internal Rate of Return. The calculations are done for you. Your task is to select the best project and explain your decision. The methods are presented and the decision each indicates is given below.

        InvestmentSales PriceCF1CF2
        Gas Station A$50,000$0$100,000
        Gas Station B$50,000$50,000$25,000


        Three (3) Capital Budgeting Methods are presented:
        1. Payback Period: Gas Station A is paid back in 2 years; CF1 in year 1, and CF2 in year 2. Gas Station B is paid back in one (1) year. According to the payback period, when given the choice between two mutually exclusive projects, the investment paid back in the shortest time is selected.
        2. Net Present Value: Consider the gas station example above under the NPV method, and a discount rate of 10%:
          NPVgas station A = $100,000/(1+.10)2 - $50,000 = $32,644
          NPVgas station B = $50,000/(1+.10) + $25,000/(1+.10)2 - $50,000 = $16,115
        3. Internal Rate of Return: Assuming 10% is the cost of funds; the IRR for Station A is 41.421%.; for Station B, 36.602.

        Summary of the Three (3) Methods:
        • Gas Station B should be selected, as the investment is returned in 1 period rather than 2 periods required for Gas Station A.
        • Under the NPV criteria, however, the decision favors gas station A, as it has the higher net present value. NPV is a measure of the value of the investment.
        • The IRR method favors Gas Station A. as it has a higher return, exceeding the cost of funds (10%) by the highest return.
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