Question

rake Corporation is reviewing an investment proposal. The initial cost and estimates of the book value of the investment at the end of each year, the net cash flows for each year, and the net income for each year are presented in the schedule below. All cash flows are assumed to take place at the end of the year. The salvage value of the investment at the end of each year is equal to its book value. There would be no salvage value at the end of the investment’s life. Investment Proposal Year Initial Cost and Book Value Annual Cash Flows Annual Net Income 0 $105,600 1 69,300 $44,900 $8,600 2 42,500 40,600 13,800 3 20,600 35,200 13,300 4 6,700 29,600 15,700 5 0 24,200 17,500 Drake Corporation uses an 11% target rate of return for new investment proposals. Click here to view PV table. (a) What is the cash payback period for this proposal? (Round answer to 2 decimal places, e.g. 10.50.) Cash payback period years (b) What is the annual rate of return for the investment? (Round answer to 2 decimal places, e.g. 10.50.) Annual rate of return for the investment % (c) What is the net present value of the investment? (If the net present value is negative, use either a negative sign preceding the number eg -45 or parentheses eg (45). Round answer to 0 decimal places, e.g. 125. For calculation purposes, use 5 decimal places as displayed in the factor table provided.) Net present value $

Answer 1

Ans. A	Year	Cash inflows	Cummulative Cash Inflows
	1	$44,900	$44,900
	2	$40,600	$85,500
	3	$35,200	$120,700
	4	$29,600	$150,300
	5	$24,200	$174,500
	Payback period = Completed years + (Investment - Cummulative cash flow of completed year) / Cash inflow of next year
		2 + ($105,600 - $85,500) / $35,200
		2 + $20,100 / $35,200
		2 + 0.57
		2.57   years
	No. of completed years consist of the years in which the Sum of cash inflows are the nearest lower value than investment.
	Cummulative Cash Inflows = Cash inflow of current year + Sum of previous year cash inflows
Ans. B	Year	Annual net income
	1	$8,600
	2	$13,800
	3	$13,300
	4	$15,700
	5	$17,500
	Total	$68,900
	Average annual net income = Total annual net income / Number of years
		$68,900 / 5
		$13,780
	*Average investment =   (Cost of investment + Salvage value) / 2
		($105,600 + $0) / 2
		$105,600 / 2
		$52,800
	Annual rate of return =   Net income / Average investment * 100
		$13,780 / $52,800 * 100
		26.10%
Ans. C	Year	Cash inflow    *	P V Factor	Present Value
	1	$44,900	0.90090	$40,450
	2	$40,600	0.81162	$32,952
	3	$35,200	0.73119	$25,738
	4	$29,600	0.65873	$19,498
	5	$24,200	0.59345	$14,361
	Total Present Value Of Cash Inflow			$133,000
	Present value of cash inflows			$133,000
	Less: Investment			-$105,600
	Net present value			$27,400
	*Calculation of Present value factors:   (PV @ 11%)
	Year		PV @ 11%
	1	1 / (1 + 0.11)^1	0.90090
	2	1 / (1 + 0.11)^2	0.81162
	3	1 / (1 + 0.11)^3	0.73119
	4	1 / (1 + 0.11)^4	0.65873
	5	1 / (1 + 0.11)^5	0.59345