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 20% each of the last three years. Casey is considering a capital budgeting project that would require a $3,600,000 investment in equipment with a useful life of five years and no salvage value. Pigeon Company's discount rate is 16%. The project would provide net operating income each year for five years as follows: $ 3,500,000 1,640,000 1,860,000 Sales Variable expenses Contribution margin Fixed expenses: Advertising, salaries, and other fixed out-of-pocket costs Depreciation Total fixed expenses Net operating income $ 710,000 720,000 1,430,000 430,000 $ 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

Answer is given below with working

Project's NPV Net Operating Income Depreciation Annual Cash inflow PV factor 16% for 5 years 1 $430,000 $720,000 $1,150,000 3.2743 Present value of Cash inflows Initial investment Net present value $3,765,438 $3,600,000 $165,438 Internal Rate of Return Year 0 Cash outflow Year 1 Cash inflow Year 2 Cash inflow Year 3 Cash inflow Year 4 Cash inflow Year 5 Cash inflow 2 -$3,600,000 $1,150,000 $1,150,000 $1,150,000 $1,150,000 $1,150,000 Internal Rate of Return 18.0% Simple rate of return Net Operating Income Initial Investment $430,000 11.9% $3,600,000 4 a) Company may want Casey to pursue the opportunity since NPV is positive 4 b) Casey may not be inclined to purse the opportunity since his historical returns has been above 20% for each of the past 3 years