Casey Nelson is a divisional manager for Pigeon Company. His annual pay raises a
ID: 2431805 • Letter: C
Question
Casey Nelson is a divisional manager for Pigeon Company. His annual pay raises are largely determined by his division’s return on investment (ROI), which has been above 24% each of the last three years. Casey is considering a capital budgeting project that would require a $4,450,000 investment in equipment with a useful life of five years and no salvage value. Pigeon Company’s discount rate is 20%. The project would provide net operating income each year for five years as follows:
Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using tables.
What is the project’s simple rate of return? (Round percentage answer to 1 decimal place. i.e. 0.123 should be considered as 12.3%.)
Casey Nelson is a divisional manager for Pigeon Company. His annual pay raises are largely determined by his division’s return on investment (ROI), which has been above 24% each of the last three years. Casey is considering a capital budgeting project that would require a $4,450,000 investment in equipment with a useful life of five years and no salvage value. Pigeon Company’s discount rate is 20%. The project would provide net operating income each year for five years as follows:
Explanation / Answer
Annual cash flows = 660000+890000= $1550000 1 Present value of annual cash flows 4636050 =1550000*2.991 Less: Investment 4450000 Net present value 186050 2 PV factor for internal rate of return = 4450000/1550000= 2.871 Internal rate of return = 22% 3 Simple rate of return = Net operating income/Investment = 660000/4450000= 14.8% 4a Yes, as net present value is positive b No, as simple rate of return is less than division’s return on investment (ROI)