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.

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.)

(b)

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

(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.)

Investment Proposal Year Initial Cost
and Book Value Annual
Cash Flows Annual
Net Income 0 $104,500 1 69,600 $44,000 $9,100 2 41,900 39,500 11,800 3 21,600 35,900 15,600 4 8,300 31,000 17,700 5 0 25,400 17,100

Explanation / Answer

Payback Period = A +B/C

Year Cash Flows Discount factor @11% Discounted Cash Flows Cumulative cash flows Discount factor @22% Discounted Cash Flows Discount factor @22.62% Discounted Cash Flows 0 -104500 1 -104500 -104500 1 -104500 1 -104500 1 44000 0.900901 39639.64 -60500 0.81967 36065.57 0.81553 35883.22 2 39500 0.811622 32059.09 -21000 0.67186 26538.56 0.66509 26270.87 3 35900 0.731191 26249.77 14900 0.55071 19770.38 0.54240 19472 4 31000 0.658731 20420.66 45900 0.45140 13993.37 0.44234 13712.49 5 25400 0.593451 15073.66 71300 0.37000 9397.981 0.36074 9162.778 NPV 28942.82 1265.869 1.357048 Ans c NPV 28943 ans a Payback period=

Payback Period = A +B/C

Where A is the last period with a negative cumulative cash flow; B is the absolute value of cumulative cash flow at the end of the period A; C is the total cash flow during the period after A 3+(21000/35900) 3.58 years Ans Anc C Annual rate of return 22.62% is IRR where NPV is 0 By trial and error method Lets take 22% Now we will take 22.62%

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