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		$104,500
1		69,900			$46,000			$11,400
2		41,000			40,600			11,700
3		21,000			34,800			14,800
4		7,600			31,000			17,600
5		0			24,600			17,000

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

What is the cash payback period for this proposal?

What is the annual rate of return for the investment?

Net present value?

Answer 1

1

cash payback period for this proposal

Year	Annual	Cumulative
	Cash Flows	Cash flow
0
1	$46,000	$46,000
2	40,600	86,600
3	34,800	121,400
4	31,000	152,400
5	24,600	177,000

As we can see for the table that company can recover the money in the third year so payback period is

=2 year + (1*17900/34800)

= 2 year + 0.51 year

=2.51 year

payback period for this proposal =2.51 year

_______________________________________________

2

Annual rate of return for the investment

Average income

= Total Income/ no of years

=(11400+11700+14800+17600+17000) /5

=72500/5

=14500

Average Investment

= $104500/2

=$52,250

Annual rate of return = Average income/ Average Investment

                                        =($14500/52500) x 100

                                        =27.75%

________________________________________________________

3

Net present value

Year	Annual	PV factor
0	Cash Flows	at 11%	Present value
0	($104,500)	1	-104500
1	46000	0.9009	41441.4
2	40600	0.8116	32951.9
3	34800	0.7312	25445.5
4	31000	0.6587	20420.7
5	24600	0.5935	14598.9
NPV			30358.3

Net present value =$30,358