Question

Problem 12-17 Net Present Value Analysis; Internal Rate of Return; Simple Rate of Return (L012-2, LO12 3, L012-6) 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 $5,620,000 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: Sales $5,000,000 2,240,000 2,760,000 Variable expenses Contribution margin Fixed expenses! Advertising, salaries, and other fixed out-of-pocket costs Depreciation Total fixed expenses Net operating income $ 860,000 1,124,000 1,984,800 776,000 $ Click here to view Exhibit 128-1 and Exhibit 128-2. 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? 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? Complete this question by entering your answers in the tabs below. Reg 2 Req3 Req 4A What is the project's net present value? (Round your final answer to the nearest whole dollar amount

Answer 1

Net operating income	776000
Add: Depreciation	1124000
Net cash flows	1900000
1
	Now	Year 1	Year 2	Year 3	Year 4	Year 5
Investment cost	-5620000
Net cash flows		1900000	1900000	1900000	1900000	1900000
Total cash flows	-5620000	1900000	1900000	1900000	1900000	1900000
PV factor @ 19%	1	0.840	0.706	0.593	0.499	0.419
Present value of cash flows	-5620000	1596000	1341400	1126700	948100	796100
Net present value	188300
2
PV factor internal rate of return=5620000/1900000 = 2.958
The PV factor 2.958 for 5 years is closest to 21%
Internal rate of return = 21%
3
Simple rate of return = Net operating income/Investment cost
Simple rate of return = 776000/5620000= 13.8%
4a
Yes, the company would want Casey to pursue this investment as Net Present value is positive
4b
No, Casey would not be inclined to pursue this investment as as his ROI will decrease