Question

Drake Corporation is reviewing an investment proposal. The initial cost is $106,400. 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			$44,500			$7,400
2		41,500			40,300			12,500
3		20,100			36,000			14,600
4		8,600			29,300			17,800
5		0			25,460			16,860

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

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

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

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.)

Answer 1

(a)-Cash Payback Period

Year	Cash Flows	Cumulative net Cash flow
0	-1,06,400	-1,06,400
1	44,500	-61,900
2	40,300	-21,600
3	36,000	14,400
4	29,300	43,700
5	25,460	69,160

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

= 2 Year + ($21,600 / $36,000)

= 2 Year + 0.60 years

= 2.60 Years

“Cash Payback Period = 2.60 Years”

(b)- Annual rate of return for the investment

Annual Rate of Return = (Average Net Income / Average Investment) x 100

Average Net Income = [$7,400 + 12,500 + 14,600 + 17,800 + 16,860] / 5 Years

= $13,832

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

= [$106,400 + $0] / 2

= $53,200

Therefore, the Annual Rate of Return = (Average Net Income / Average Investment) x 100

= [$13,832 / $53,200] x 100

= 26.00%

“Annual Rate of Return = 26.00%”

(c)-Net Present Value (NPV)

Year	Annual Cash Inflow ($)	Present Value Factor at 11%	Present Value of Annual Cash Inflow ($)
1	44,500	0.90090	40,090
2	40,300	0.81162	32,708
3	36,000	0.73119	26,323
4	29,300	0.65873	19,301
5	25,460	0.59345	15,109
TOTAL			1,33,531

Net Present Value = Present Value of annual cash inflows – Present value of cash outflows

= $1,33,531 - $106,400

= $27,131

“Net Present Value = $27,131”

NOTE

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