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 24% each of the last three years. Casey is considering a capital budgeting project that would require a $6,100,000 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			$	5,400,000
Variable expenses				2,400,000
Contribution margin				3,000,000
Fixed expenses:
Advertising, salaries, and other fixed out-of-pocket costs	$	900,000
Depreciation		1,220,000
Total fixed expenses				2,120,000
Net operating income			$	880,000

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

NPV= $ 181100

IRR= 21.66℅

SIMPLE RATE OF RETURN= 14.43℅

4(A)= YES

4(B)= NO

FOR EXPLANATION PLEASE REFER THE PICTURES ATTACHED
I formulas Net present Value - besent Value - Present of Inflows value of before depr. n outflows besent value of inflows & Net operating Irlane X before depu before dep. bescut Value factor Net operatory Income & P.V. factor / before dep Ned operating income a Net operating Income before lep & depreciation Here Net operating income $ 880000 Repercbatean ' $ 12 29000 Net operating Income - pesoooo + 220,000 befor help - $ 210.000 dogg P. X Factor eut 20% discomt Rate for 5 years P.v. of our flows = blagas

I brescut - N.o Income y PVAL 20%-957. value of Inflows befor keep = dlowcw x 2.991 = 628180 Net present value = present Value - out flows y No of Inflows to da 6281160 - 61 como el NaP.V. = $ 18lileo I 2 IRR / Internal Rate of Return. In At IRR , Bescut value of Inflows = pescut value of outflius besent value of Inflows = Annual operating X PYAF, Sym I Income before alley Being above equation in the giren situation

blow: low x PVAL, Syrs = PVAL, 5465 & Glocio مه PV Af, sypos. a 2.90476 Between 217 & 22 % | Puaf, syns at alt. -2-926 and PVAL, 22 %., eet syn 2 2-863-6 227–218) Praf, 5Y97890476 = 214% +12.906-J-8636 fole926-2-8636/1 e 21% 4 0.0414 67 T00624 27. t. 0.66 a 21.66% T. IRR = 216677

3 Simple Rate of Return = Net operating Iream flew Investment 886ooo lo 6 wew 3. R og Retiren 14043% / 480) Yes, the Company want Casey to - Puesue this innustuent opportunity, as the net present value of the 14 investment is positive. 466) No Casey not be inclined to pursue this investment oppor- tunidy as the simple Rate of Retuen from the investment is only 14.434. which is lower than the overall division's Retuen on Twestwent j.e. 24%.. it would not increase the overall profitability Return of the division."