Casey Nelson is a divisional manager for Pigeon Company. His annual pay raises a
ID: 2531480 • 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:
Click here to view Exhibit 11B-1 and Exhibit 11B-2, to determine the appropriate discount factor(s) using tables.
What is the project’s net present value? (Use the appropriate table to determine the discount factor(s).)
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 $4,200,000 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:
Explanation / Answer
(1) What is the project’s net present value?
Net present value (NPV) at 20% = $1,36,385 (Positive)
Annual Cash flow = Net Income + Depreciation
= $6,10,000 + $8,40,000
= $14,50,000
Net present value (NPV) = Present Vale of cash flows – Estimated costs
= [ $14,50,000 x (PVAF 20%,5Years) ] -$42,00,000
= [ $14,50,000 x 2.99061- $42,00,000
= $43,36,385 - $42,00,000
= $1,36,385 (Positive)
(2) What is the project’s simple rate of return?
Project’s simple rate of return = 14.5%
Simple rate of Return = (Net Income/Investment) x 100
= ($6,10,000 / $42,00,000) x 100
= 14.5%
3(a) Would the company want Casey to pursue this investment opportunity = YES
3(b) Would Casey be inclined to pursue this investment opportunity = YES