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 woul require a $3,000,000 investment in equipment with a useful life of five years and no salvage value. Holston Company's discount rate 15%. The project would provide net operating income each year for five years as follows: $2,500,000 1,000,000 1,500,000 Sales Variable expenses Contribution margin Fixed expenses: Advertising, salaries, and other fixed out-of-pocket costs Depreciation Total fixed expenses Net operating income $ 600,000 600,000 1,200,000 $ 300,000 Click here to view Exhibit 7B-1 and Exhibit 7B-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? Complete this question by entering your answers in the tabs below. Req 1 Reg 2 Req ЗА Req 3B Compute the project's net present value. (Round your final answer to the nearest whole dollar amount.) Net present value Reg 1 Req2 >

Answer 1

Net operating income	300000
Add: Depreciation	600000
Net annual cash flows	900000
1
	Year 1	Year 2	Year 3	Year 4	Year 5
Net annual cash flows	900000	900000	900000	900000	900000
X PV factor @ 15%	0.870	0.756	0.658	0.572	0.497
Present value of Net annual cash flows	783000	680400	592200	514800	447300
Total present value	3017700
Less: Investment cost	3000000
Net present value	17700
2
Simple rate of return = Net operating income/Investment cost
Simple rate of return = 300000/3000000= 10%
3a
Yes the company would want Derrick to pursue to this investment opportunity
3b
No, Derrick would not be inclined to pursue to this investment opportunity as his ROI will decrease