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 $105,900 1 69,300 $44,100 $7,500 2 42,600 40,300 13,600 3 20,000 35,000 12,400 4 6,500 29,800 16,300 5 0 24,400 17,900

Explanation / Answer

a) Pay back period

      The project's payback is 3 years.

    By the conclusion of this time period, drake will have recovered the investment's cost of $105,900 ($44,100 + $40,300 + $35,000 =$119,400).

      Therefore pay back period = 3 years

b)Accounting rate of return (ARR)

                  ARR=average income/initial investment

                    ARR=($67,700/5)/$105,900=12.78%

        Accounting rate of return =12.78%

c) Net present value (NPV)    @ 11%

       year 0                105,900*1                  =   ($105,900)

       year 1                44,100*0.901             =       $39,734.1

       year 2                 40,300*0.812            =       $32,723.6

       year 3                 35,000*0.731            =       $25,585

       year 4                 29,800*0.659            =       $19,638.2

       year 5                  24,400*0.593           =       $14,469.2

                       Net present value                =       $26,250.1

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