Question

Drake Corporation is reviewing an investment proposal. The initial cost is $103,400. 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 Annual Annual Year Book Value Cash Flows Net Income 1 $69.000 $44,000 $9,600 2 41,000 39,000 11,000 3 20,000 34,000 13,000 4 6,000 29,000 15,000 50 24,610 18,610 Drake Corporation uses an 11% target rate of return for new investment proposals. Click here to view PV table. What is the cash payback period for this proposal? (Round answer to 2 decimal places, e... 10.50.) Cash payback period years (b) What is the annual rate of return for the investment? (Round answer to 2 decimal places, e... 10.50%.) Annual rate of return for the investment (c) decimal places, e.g. 125. For calculation purposes, use 5 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 decimal places as displayed in the factor table provided.) Net present value $

Answer 1

(a)-Cash Payback Period

Year	Cash Flows ($)	Cumulative net Cash flow ($)
0	-1,03,400	-1,03,400
1	44,000	-59,400
2	39,000	-20,400
3	34,000	13,600
4	29,000	42,600
5	24,610	67,210

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

= 2.00 Year + ($20,400 / $34,00)

= 2.00 Year + 0.60 years

= 2.60 Years

(b)-Annual Rate of Return for the Investment

Average Net Income = Total Net Income / 5 Years

= [$9,600 + $+ $11,000 + $13,000 + $15,000 + $18,610] / 5 Years

= $67,210 / 5 Years

= $13,442 per year

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

= [$103,400 + $0] / 2

= $103,400 / 2

= $51,700

Annual Rate of Return for the Investment = [Average Net Income / Average Investment] x 100

= [$13,442 / $51,700] x 100

= 26.00%

(c)-Net Present Value (NPV)

Year	Annual cash flows ($)	Present Value Factor (PVF) at 11.00%	Present Value of annual cash flows ($) [Annual cash flow x PVF]
1	44,000	0.90090	39,640
2	39,000	0.81162	31,653
3	34,000	0.73119	24,860
4	29,000	0.65873	19,103
5	24,610	0.59345	14,605
TOTAL		1,29,861

Net Present Value (NPV) = Present Value of annual cash inflows – Initial Investment

= $1,29,861 - $103,400

= $26,461

NOTE    

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