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 $5,850,000 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:
| Sales | $ | 5,200,000 | ||
| Variable expenses | 2,320,000 | |||
| Contribution margin | 2,880,000 | |||
| Fixed expenses: | ||||
| Advertising, salaries, and other fixed out-of-pocket costs |
$ | 880,000 | ||
| Depreciation | 1,170,000 | |||
| Total fixed expenses | 2,050,000 | |||
| Net operating income | $ | 830,000 | ||
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?
| Net operating income | 830000 | |||||
| Add: Depreciation | 1170000 | |||||
| Net cash flows | 2000000 | |||||
| 1 | ||||||
| Now | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | |
| Investment cost | -5850000 | |||||
| Net cash flows | 2000000 | 2000000 | 2000000 | 2000000 | 2000000 | |
| Total cash flows | -5850000 | 2000000 | 2000000 | 2000000 | 2000000 | 2000000 |
| PV factor @ 20% | 1 | 0.833 | 0.694 | 0.579 | 0.482 | 0.402 |
| Present value of cash flows | -5850000 | 1666000 | 1388000 | 1158000 | 964000 | 804000 |
| Net present value | 130000 | |||||
| 2 | ||||||
| PV factor internal rate of return=5850000/2000000 = 2.925 | ||||||
| The PV factor 2.925 for 5 years is closest to 21% | ||||||
| Internal rate of return = 21% | ||||||
| 3 | ||||||
| Simple rate of return = Net operating income/Investment cost | ||||||
| Simple rate of return = 830000/5850000= 14.2% | ||||||
| 4a | ||||||
| Yes, the company would want Casey to pursue this investment as Net Present value is positive | ||||||
| 4b | ||||||
| No, Casey would not be inclined to pursue this investment as as his ROI will decrease | ||||||
Casey Nelson is a divisional manager for Pigeon Company. His annual pay raises are largely determined...
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 $5,850,000 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:...
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 23% each of the last three years. Casey is considering a capital budgeting project that would require a $5,620,000 investment in equipment with a useful life of five years and no salvage value. Pigeon Company’s discount rate is 19%. The project would provide net operating income each year for five years as follows:...
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 $5,050,000 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:...
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 $5,050,000 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:...
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 23% each of the last three years. Casey is considering a capital budgeting project that would require a $5,620,000 investment in equipment with a useful life of five years and no salvage value. Pigeon Company’s discount rate is 19%. The project would provide net operating income each year for five years as follows:...
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