Casey Nelson is a divisional manager for Pigeon Company. His annual pay raises a
ID: 2533551 • 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 23% each of the last three years. Casey is considering a capital budgeting project that would require a $4,000,000 investment in equipment with a useful life of five years and no salvage value. Pigeon Company’s discount rate is 19%. 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.
Required:
1. What is the project’s net present value?
2. What is the project’s internal rate of return to the nearest whole percent?
3. What is the project’s simple rate of return?
4-a. Would the company want Casey to pursue this investment opportunity?
4-b. Would Casey be inclined to pursue this investment opportunity?
Sales $ 3,900,000 Variable expenses 1,800,000 Contribution margin 2,100,000 Fixed expenses: Advertising, salaries, and otherfixed out-of-pocket costs $ 750,000 Depreciation 800,000 Total fixed expenses 1,550,000 Net operating income $ 550,000
Explanation / Answer
1.What is the project’s net present value?
Cash Flow = Net Income + Depreciation
= $550000 + 800000 = $13,50,000
Net present value (NPV) at 19% = $1,27,801
= [ $13,50,000 x (PVAF 19%,5 Years) ] - $40,00,000
= [ ($1350000 x 3.05763 ) - $40,00,000
= $1,27,801
2. What is the project’s internal rate of return to the nearest whole percent?
Present Value Factor = $40,00,000 / $1350000
= 2.96296
From the PVA Factor Table, IRR corresponding to 2.96296 for 5 years = 20%
Therefore, Internal Rate of Return = 20%
3. What is the project’s simple rate of return?
simple rate of return = (Net Income / Initial Investments) * 100
= ($550000 / 4000000) * 100
= 13.75%
4-a. Would the company want Casey to pursue this investment opportunity?
YES
4-b. Would Casey be inclined to pursue this investment opportunity?
YES