Exercise 2411 Drake Corporation is reviewing an investment p

Exercise 24-11

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.)

Solution

(a) .... Payback period and Cash payback period are one and same.

As seen in the above table ........... by the end of 2 years we still have ......... a balance of 17900 to be recovered from the investment.

2 Years + 17900 / 34800 = 2.51 Years

(b) Annual rate of return or Average rate of return = Average Net Income / Average Investment * 100

Here Average Net Income = Total Net Income / 5 Years = 72500 / 5 = 14500

Average Investment = 104,500 / 2 = 52250

ARR = 14500 / 52250 * 100 = 27.75 %

Question - c