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		$105,700
1		69,800			$44,200			$8,300
2		43,000			40,400			13,600
3		21,100			35,000			13,100
4		7,000			29,000			14,900
5		0			26,000			19,000

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

Solution a:

Computation of cumulative cash flows
Year	Cash Flows	Cumulative cash flows
1	$44,200.00	$44,200.00
2	$40,400.00	$84,600.00
3	$35,000.00	$119,600.00
4	$29,000.00	$148,600.00
5	$26,000.00	$174,600.00

Payback period = 2 years + ($105,700 - $84,600) / $35,000 = 2.60 years

Solution b:

Annual rate of return = Average annual income / Average investment

Average annual income = ($8,300 + $13,600 + $13,100 + $14,900 + $19,000)/5 = $13,780

Average investment = (Initial investment  + Salvage value)/2 = ($105,700 + 0) /2 = $52,850

Annual rate of return = $13,780 / $52,850 = 26.07%

solution c:

Computation of NPV - Drake Company
Particulars	Amount	Period	PV Factor	Present Value
Cash Outflows:
Initial investment	$105,700.00	0	1	$105,700
Present Value of Cash Outflows (A)				$105,700
Cash Inflows:
Year 1	$44,200.00	1	0.90090	$39,820
Year 2	$40,400.00	2	0.81162	$32,789
Year 3	$35,000.00	3	0.73119	$25,592
Year 4	$29,000.00	4	0.65873	$19,103
Year 5	$26,000.00	5	0.59345	$15,430
Present Value of Cash Inflows (B)				$132,734
Net Present Value (B-A)				$27,034