Question

2 Derrick Iverson is a divisional manager for Holston 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. Derrick 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. Holston Company's discount rate is 16%. The project would provide net operating income each year for five years as follows: 10 points Sales $3,200,000 1,350,000 1,850,000 еВook Variable expenses Contribution margin Fixed expenses: Advertising, salaries, and Hint other fixed out-of-pocket costs Depreciation Total fixed expenses $670,000 760,000 Ask 1,430,000 $ 420,000 Net operating income Print Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using tables. References Required: 1. Compute the project's net present value. 2. Compute the project's simple rate of return 3a. Would the company want Derrick to pursue this investment opportunity? 3b. Would Derrick be inclined to pursue this investment opportunity? Complete this question by entering your answers in the tabs below. Req 1 Req 2 Req ЗA Req 3B Compute the project's net present value. (Round your final answer to the nearest whole dollar amount.) Net present value Req 1 Req 2

Answer 1

A C D E 1 Net operating income 420000 2 Add: Depreciation 760000 3 Net annual cash flows 11800001 4 5 6 Year 1 Year 2 Year 3 Year 4 Year 5 7 Net annual cash flows 1180000 1180000 1180000 1180000 1180000 8 X PV factor @ 18% 0.862 0.743 0.641 0.552 0.476 9 Present value of Net annual cash flows 1017160 876740 756380651360 561680| 10 Total present value 3863320 11 Less: Investment cost 38000001 12 Net present value 633200 13 14 15 Simple rate of return = Net operating income/Investment cost 16 Simple rate of return = 420000/3800000= 11.05% Z 17 18 3a 19 Yes the company would want Derrick to pursue to this investment opportunity 20 21 3b 22 No, Derrick would not be inclined to pursue to this investment opportunity as his ROI will decrease