Drake Corporation is reviewing an investment proposal. The initial cost and esti

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?

Correct (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 26.07 %

?(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 $ ???

Legend Service Center just purchased an automobile hoist for $32,700. The hoist has an 8-year life and an estimated salvage value of $3,350. Installation costs and freight charges were $3,710 and $870, respectively. Legend uses straight-line depreciation.

The new hoist will be used to replace mufflers and tires on automobiles. Legend estimates that the new hoist will enable his mechanics to replace 7 extra mufflers per week. Each muffler sells for $74 installed. The cost of a muffler is $35, and the labor cost to install a muffler is $16.

(a) Compute the cash payback period for the new hoist. (Round answer to 2 decimal places, e.g. 10.50.)

(b) Compute the annual rate of return for the new hoist. (Round answer to 1 decimal place, e.g. 10.5.

Explanation / Answer

All Amounts in $ Drake Corporation (a) To calculate the cash payback period, we need to assess within what time frame are the cash outflows recovered back Year Cash Outflow Cash Inflow 0 105700 1 44200 2 40400 3 35000 4 29000 5 26000 From the table above, it can be seen that out of $ 105,700, $ 86,600 is recovered in two years. The balance $ 19,100 is recovered is ($ 19,100 / $ 35,000) X 12 = 6.5486 months Thus, the cash payback period is 2 years 6.55 months or 2 years 7 months (rounded off). (b) To calculate the annual rate of return, we need to assess the net income per year Year Net Income 1 8300 2 13600 3 13100 4 14900 5 19000 68900 Thus, the average accounting rate of return for 5 years is $ 68,900 / $ 105,700 = 65.18% Hence, the annual rate of return per year works out to 13.04% (c) For calculating the NPV, we need to consider the Cash inflows and outflows for the investment with a target rate of return of 11% thereon Based on the factors above, the Net Present Value of the investment works out to $ 24,354.95 Legend Service Center (a) Original Cash Outflows at Year t = 0 are $ 32,700 + $ 3,710 + $ 870 = $ 37,280 Estimated Cash Inflow per year from sale of additional mufflers Additional mufflers sold per week 7 Additional sale on an annual basis 364 Net Income from Sale 23 $ per muffler (Sale Price - Cost - Labor Charges) Annual Cash Inflow from additional sales 8372 $ To recover $ 37,280, the cash payback period will be Year Amount 1 8372 2 8372 3 8372 4 8372 4 years 5 3792 5.4353 months Hence, the total cash payback period will be 4 years and 5.4 months or 4 years 5 months (rounded off). (b) Total Cash Inflows from years 1 to 8 @ $ 8,372 per year = 66976 $ The annual rate of return for 8 years will be $ 66,976 / $ 37,280 = 179.66% Hence, the average annual rate of return per year will be 179.66% / 8 = 22.46%

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