Question

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 $4,200,000 investment in equipment with a useful life of five years and no salvage value. Holston Company's discount rate is 18%. The project would provide net operating income each year for five years as follows: $3,600,000 1,550,000 2,050,000 Sales Variable expenses Contribution margin Fixed expenses: Advertising, salaries, and other fixed out-of-pocket costs Depreciation Total fixed expenses Net operating income $ 700,000 840,000 1,540,000 $ 510,000 Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using tables. 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?

Answer 1

* Derrick Iverson is Reg. 12.14 % (17 Project's net present value $ 21450 @] Project's simple sake of zeturn (3a) would company pusue this opportunity YES (316) would Derrick be inclined 10 puasve this orp. NO Explanation: (11 Net Income + pep. $ 510,000 + 840,000 Net cash inflow $13,50,000 (2) Net present value: (Discount sole o 18%] years cash flow 1,350,000 1,350,000 1,350,000 1,350,000 1,350,000 PV factor 0.847 0.718 0.609 0.516 0.437 PU I $ 1,143 450 969 300 822150 6 9 6600 589950 L 4,221 450 (4 200 000) 1$ 21450 Sum of pv Initial Investment NPV ( PV of si table to check the pv factor) simple selle of setusn: - Net Income $ 510,000 12.147 Initial Invest $4,200,000

3(a) NPV is Positive so company want to pursue this investment OPPOTrinity 316) NO, Because his pay raise is determined by ROI which has been above 20% in the pastyears.