Question

Drake 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		$105,900
1		69,200			$44,600			$7,900
2		43,000			39,700			13,500
3		21,800			34,400			13,200
4		6,400			30,200			14,800
5		0			24,600			18,200

Drake Corporation uses an 11% target rate of return for new investment proposals.
(a)

What is the cash payback period for this proposal? (Round answer to 2 decimal places, e.g. 10.50.)

Cash payback period

(b)

What is the annual rate of return for the investment? (Round answer to 2 decimal places, e.g. 10.50.)

c.

Annual rate of return for the investment 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

(a)-Cash Payback Period

Year	Cash Flows ($)	Cumulative net Cash flow ($)
0	-1,05,900	-1,05,900
1	44,600	-61,300
2	39,700	-21,600
3	34,400	12,800
4	30,200	43,000
5	24,600	67,600

Payback Period = Years before full recover + (Unrecovered cash inflow at start of the year/cash flow during the year)

= 2.00 Year + ($21,600 / $34,400)

= 2.00 Year + 0.63 years

= 2.63 Years

(b)-Annual Rate of Return for the Investment

Average Net Income = Total Net Income / 5 Years

= [$7,900 + 13,500 + 13,200 + 14,800 + 18,200] / 5 Years

= $67,600 / 5 Years

= $13,520 per year

Average Investment = [Initial Cost + Salvage Value] / 2

= [$105,900 + $0] / 2

= $105,900 / 2

= $52,950

Annual Rate of Return for the Investment = [Average Net Income / Average Investment] x 100

= [$13,520 / $52,950] x 100

= 25.53%

(c)-Net Present Value (NPV)

Year	Annual cash flows ($)	Present Value Factor (PVF) at 11.00%	Present Value of annual cash flows ($) [Annual cash flow x PVF]
1	44,600	0.90090	40,180
2	39,700	0.81162	32,221
3	34,400	0.73119	25,153
4	30,200	0.65873	19,894
5	24,600	0.59345	14,599
TOTAL		132,047

Net Present Value (NPV) = Present Value of annual cash inflows – Initial Investment

= $132,047 - $105,900

= $26,147

NOTE    

The Formula for calculating the Present Value Factor is [1/(1 + r)n], Where “r” is the Discount/Interest Rate and “n” is the number of years.