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 23% each of the last three years. Casey is considering a capital budgeting project that would require a $5,380,000 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: $ 4,800,000 2,160,000 2,640,000 Sales Variable expenses Contribution margin Fixed expenses: Advertising, salaries, and other fixed out-of-pocket costs Depreciation Total fixed expenses Net operating income $ 840,000 1,076,000 1,916,000 724,000 $ Click here to view Exhibit 13B-1 and Exhibit 13B-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 to the nearest whole percent? 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?

Answer 1

C D EFTGTH A B Given 2 Investment 3 Net operating Income 4 Depreciation 5 Number of years Discount Rate 5380000 724000 1076000 5 years 19.0% 8 Solution 9 Step 1: Calculate Operating Cashflow 10 11 Particulars 12 Net operating Income 13 Add: Depreciation 14 Cash Flow from operating activity Amount 724000 1076000 1800000 16 Part 1&2) Calculate NPV & IRR Year Cashflow PVE PV 0 -5380000 1 -5380000 1 1800000 0.840 1512605 2 1800000 0.706 1271097 3 1800000 0.593 1068148 4 1800000 0.499 897604 1800000 0.419 754289 25 IRR 20.03% NPV 123743 26 IRR =IRR(B19:B24) 27 28 Hence, NPV is $123743 and IRR is 20.03% 29 30 PVF (Present Value Factor) = 31 where r is discount rate and n is Number of year (1/(1+r)^n 32 33 Part 3) Simple rate of return 34 35 Simple return = Operating Cashflow 36 Investment 37 Simple return = 1800000 5380000 39 Simple return = 33.46% 38 40 | 41 |Part 4a) Would company want Casey to pursure this investment opportunity 42 43 Yes, as NPV of opportunity is 123743 44 | 45 |Part 4b) Would Casey be inclined to pursure this investment opportunity 46 No, as IRR is 20.03% which is less than 23% (disvision return). Hence, if this investment 47 Jopportunity is pursued, then Casey would not receive Pay raise.