Casey Nelson is a divisional manager for Pigeon Company. His annual pay raises a
ID: 2521747 • 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 $4,200,000 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 Sales Variable expenses $4,100,000 1,880,000 2,220,000 Contribution margin Fixed expenses Advertising, salaries, and other fixed out-of-pocket costs Depreciation $770,000 840,000 Total fixed expenses 1,610,000 Net operating income $610,000 Click here to view Exhibit 11B-1 and Exhibit 11B-2, to determine the appropriate discount factor(s) using tables. Required 1. What is the project's net present value? (Use the appropriate table to determine the discount factor(s).) Net present value 2. 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%.) Simple rate of return 3-a. Would the company want Casey to pursue this investment opportunity? O Yes 0 3-b. Would Casey be inclined to pursue this investment opportunity? O Yes 0Explanation / Answer
1) Annual cash flow = 610000+840000 = 1450000 PV of annual cash flow = 1450000*PVIFA(20,5) = 1450000*2.9906 = 4336370 Less: Initial investment 4200000 NPV 136370 b) Simple rate of return = NOI/Investment = 610000/4200000 = 14.52% 3-a) Yes, as the NPV is positive. 3-b) No, as the return is less than his dividions average of 24% during the last 3 years.