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 $104,100 69,900 41,600 20,900 7,800 $44,700 40,700 35,000 29,100 25,800 $10,500 12,400 14,300 16,000 18,000 4 Drake Corporation uses an 11% target rate of return for new investment proposals

Answer 1

4 Cash flow Timeline 5 Year 6 Cash flow 7 Cumulative cash flows 鶉| 9 The projects payback period for this proposal 0 1 2 4 (104,100) 44,70040,700 35,000 29,100 25,800 (59,400) (18,700) 16,30045400 71,200 2.53 years (2+18,700/35,000)

13 The annual rate of return for the investment 14 15 ARR-Average income / Average investment 16 17 Average income 18 Year 19 Annual Net income 20 Total income 21 Average income (71,200/5 years) 22 Average Investment ($104,100/2) 23 24 ARR 0 1 2 4 5 Total - $ 10,500 12,400$ 14,300 $ 16,000 18,000 $71,200 $71,200 $ 14,240 $ 52,050 27.36%

26 The NPV of the proposal 27 28 Cash flow Timeline 29 Year 30 Cash flow 31 PV of 1 factors r=1196,n=5 32 Discounted CFs 33 Total cash outflows 34 TOTAL cash Inflows 35 36 NPV function (Inflows-outflows 37 0 2 $ (104,100)$44,700 $ 40,700 35,000$29,100 25,800 0.9009009 0.81162243 0.73119138 0.65873097 0.59345133 $ (104,100)$ 40,270 $ 33,033 25,592$19,169 15,311 $ (104,100) $ 133,375.12 $29,275.12