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 Initial Cost and Book Annual Cash Flows Annual Net Income Year Value $104,500 69,900 41,000 21,000 7,600 0 0 $46,000 40,600 34,800 31,000 24,600 $11,400 11,700 14,800 17,600 17,000 Drake Corporation uses an 11% target rate of return for new investment proposals

Explanation / Answer

Solution:

Accounting/Annual Rate of Return

Net Income means Average Annual Net Income after Depreciation and Taxes

ARR =    

Average Annual Net Income = (11,400 + 11700 + 14800 + 17600 + 17000) / 5 = $14,500

Initial Investment = $104,500

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

= $14,500 / 104,500 x 100

= 13.88%

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