Question

SOLVE FOR REQUIRED 1-4b. please explain answers.

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 22% each of the last three years. Casey is considering a capital budgeting project that would require a $3,800,000 investment in equipment with a useful life of five years and no salvage value. Pigeon Company's discount rate is 18%. The project would provide net operating income each year for five years as follows: $ 3,700,000 1,720,000 1,980,000 Sales Variable expenses Contribution margin Fixed expenses: Advertising, salaries, and other fixed out-of-pocket costs Depreciation Total fixed expenses Net operating income $ 730,000 760,000 1,490,000 490,000 $ 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?

Answer 1

Solution 1:

Annual net Cash Inflow
Net Operating Income	$4,90,000
Add: Depreciation	$7,60,000
Net Cash Flow	$12,50,000

	Chart Values are based on
	n=	5
	i=	18%
Cash Flow	Select Chart	Amount	*	PV Factor	=	Present Value
Annual Net cash Inflow	Present Value of an annuity of 1	$12,50,000		3.127	=	$39,08,750
	Present value of cash inflows					$39,08,750
	Present value of cash outflows					-$38,00,000
	Net Present Value					$1,08,750

Solution 2:

	Project A
Period	Cash flows	IRR
0	-$38,00,000	19%
1	$12,50,000
2	$12,50,000
3	$12,50,000
4	$12,50,000
5	$12,50,000

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Solution 3:

Simple rate of Return
Choose Numerator	/	Choose Denominator	=	Accounting Rate of Return
Annual Net operating Income	/	Initial Investment	=	Accounting Rate of Return
$4,90,000	/	$38,00,000	=	12.9%

Solution 4a:

Yes, the company would want Casey to pursue this investment opportunity because IRR (19%) is more than Company's Discount rate of return (18%).

Solution 4b:

No, Casey would not be inclined to pursue this investment opportunity because Simple rate of return (12.9%) is much less than division's ROI (22%).