Question

Drake Corporation is reviewing an investment proposal. The initial cost is $107,100. 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 assumed to equal its book value. There would be no salvage value at the end of the investment’s life.

Investment Proposal     

Year                       Book Value                     Annual Cash Flows            Annual Net Income

1                              $69,300                                 $44,900                                 $7,100                  

2                              42,500                                   40,600                                   13,800                  

3                              20,600                                   36,000                                   14,100                  

4                              6,700                                     29,600                                   15,700                  

5                              0                                              25,615                                   18,915                  

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

Use 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 in 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 in (%)                  

(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 e.g. -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

Computation of cumulative cash flows
Year	Cash Flows	Cumulative cash flows
1	$44,900.00	$44,900.00
2	$40,600.00	$85,500.00
3	$36,000.00	$1,21,500.00
4	$29,600.00	$1,51,100.00
5	$25,615.00	$1,76,715.00

cash payback period = 2 + ($107100 -85500)/ 36000 = 2.60 years

b.

Annual rate of return = Average annual income / Average investment

Average annual income =(7100+13800+14100+15700+18915)/5 = $13,923

Average investment = (Initial investment  + Salvage value)/2 = ($107,100 + 0) /2 = $53,550

Annual rate of return = $13923 / $53550 = 26.00%

c.

Computation of NPV - Drake Company
Particulars	Amount	Period	PV Factor	Present Value
Cash Outflows:
Initial investment	$1,07,100.00	0	1	$1,07,100
Present Value of Cash Outflows (A)				$1,07,100
Cash Inflows:
Year 1	$44,900.00	1	0.90090	$40,450
Year 2	$40,600.00	2	0.81162	$32,952
Year 3	$36,000.00	3	0.73119	$26,323
Year 4	$29,600.00	4	0.65873	$19,498
Year 5	$25,615.00	5	0.59345	$15,201
Present Value of Cash Inflows (B)				$1,34,425
Net Present Value (B-A)				$27,325