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Peace of Mind, Inc. (PMI) sells extended warranties for durable consumer goods such as washing machines and refrigerators. When PMI sells an extended warranty, it receives cash up front from the customer but later, it must cover any repair costs that arise.
An analyst working for PMI is considering a warranty for a new line of big-screen TVs. A consumer who purchases the 2-year warranty will pay PMI $210. On average, the repair costs that PMI must cover will average $106 for each of the warranty's 2 years.
If PMI has a cost of capital of 7%, should it offer this warranty for sale?

Respuesta :

Answer:

Yes

Explanation:

The computation of the Internal rate of return and the net present value is shown below:

Year          Particulars       Cash flows       PVIF at 7%      Present value

0              Initial cost           210                     1                         210

1             Year 1 cash inflows  -106             0.934579439     -99.06542056

2           Year 2 cash inflows   -106            0.873438728      -92.5845052

IRR                                   0.63%  

NPV                                                                                            $18.35

The IRR and the NPV is 0.63% and $18.35 so it should be accepted as the NPV comes in a positive amount

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