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 $4,300,000 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: $ 4,200,000 1,928,888 2,280, eee Sales Variable expenses Contribution margin Fixed expenses: Advertising, salaries, and other fixed out-of-pocket costs Depreciation Total fixed expenses Net operating income $ 780,000 860, eee 1.640 Bee 640,000 $ Click here to view Exhibit 12B-1 and Exhibit 12B-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 1 Reg 2 Reg 3 Reg 4 Reg 4B What is the project's net present value? (Round your final answer to the nearest whole dollar amount. Net present value

Answer 1

Computation of Net Present Value - Casey Nelson
	Annual net cash flows	PV factor @20%	Present value
Year-0	-$4,300,000	1.00000	-$4,300,000
Year 1	$1,500,000	0.83333	$1,250,000
Year 2	$1,500,000	0.69444	$1,041,667
Year 3	$1,500,000	0.57870	$868,056
Year 4	$1,500,000	0.48225	$723,380
Year 5	$1,500,000	0.40188	$602,816
Net Present Value			$185,918
Net annual cash flows = Net operating income + Depreciation
Net annual cash flows = 640000+860000= $1500000

Computation of IRR

PV factor for internal rate of return = Investment cost/Annual cash flows

PV factor for internal rate of return = 4300000/1500000= 2.867

The PV factor 2.867 for 5 years us closest to 22%

Internal rate of return = 22%

Computation of simple rate of return

Simple rate of return = Net operating income /Investment cost

Simple rate of return = 640000/4300000= 14.88%