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		$104,100
1		69,400			$44,300			$9,600
2		42,600			39,700			12,900
3		20,500			34,600			12,500
4		8,800			30,300			18,600
5		0			24,700			15,900

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.)

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	$44,300.00	$44,300.00
2	$39,700.00	$84,000.00
3	$34,600.00	$1,18,600.00
4	$30,300.00	$1,48,900.00
5	$24,700.00	$1,73,600.00

Payback period = 2 years + ($104100 - $84000) / $34600 = 2.58 years

Solution b:

Annual rate of return = Average annual income / Average investment

Average annual income = ($9,600 + $12,900 + $12,500 + $18,600 + $15,900)/5 = $13,900

Average investment = (Initial investment  + Salvage value)/2 = ($104,100 + 0) /2 = $52,050

Annual rate of return = $13,900 / $52,050 = 26.71%

Solution c:

Computation of NPV - Drake Company
Particulars	Amount	Period	PV Factor	Present Value
Cash Outflows:
Initial investment	$1,04,100.00	0	1	$1,04,100
Present Value of Cash Outflows (A)				$1,04,100
Cash Inflows:
Year 1	$44,300.00	1	0.90090	$39,910
Year 2	$39,700.00	2	0.81162	$32,221
Year 3	$34,600.00	3	0.73119	$25,299
Year 4	$30,300.00	4	0.65873	$19,960
Year 5	$24,700.00	5	0.59345	$14,658
Present Value of Cash Inflows (B)				$1,32,048
Net Present Value (B-A)				$27,948