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		$105,400
1		69,100			$45,900			$9,600
2		42,300			39,600			12,800
3		21,100			35,100			13,900
4		8,200			30,500			17,600
5		0			24,900			16,700

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

PART – a)

For computing the payback period, cumulative cash flows is computed by adding the cash flows as follows:

The result of cumulative cash flows is as follows:

Payback period = Years before complete recovery + (Balance unpaid to cover/Cash flows in the period of final recovery)

= 2 years + [($105,400 – $85,500)/$35,100]

= 2 years + ($19,900/$35,100)

= 2 years + 0.56695

= 2.57 years (Approx.)

PART – b).

Average income = Total income/Total years

                           = ($9,600 + $12,800 + $13,900 + $17,600 + $16,700)/5

                           = $70,600/5

                           = $14,120

Average investment is computed as follows by using the following formulas in the excel sheet:

The result of the average annual investment by using the above excel sheet is as follows:

ARR (Annual rate of return) = (Average Income/Average annual investment)*100

                                              = ($14,120/$96,825)*100

                                              = 14.58% (approx.)

PART – c)

For computing the NPV on excel, we can apply the formula of NPV i.e.

=NPV(Discount rate, cash flow cells)

The NPV is computed by using the following formula in the excel sheet as follows:

The NPV is computed by using the above excel formula:

Thus,

NPV = $134,024.6

         = $134,025 (approx.)