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 $4,100,000 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: Sales Variable expenses Contribution margin Fixed expenses 5 4,800,800 1,840,8ee 2,168,800 Advertising, salaries, and other fixed out-of-pocket costs Depreciation $ 768,90e 828,888 Total fixed expenses Net operating income 1,580,88 $ 580,800 Click here to view Exhibit 138-1 and Exhibit 138-2, 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? Complete this question by entering your answers in the tabs below. Req 2 Req 4 Rq 4B Req 1 Req 3 Would Casey be inclined to pursue this investment opportunity? Yes No

Answer 1

(1)- Net present value (NPV)

Annual Cash Inflow = Net Operating Income + Depreciation

= $580,000 + 820,000

= $14,00,000

Net present value (NPV) = Present Vale of annual cash inflows – Initial Investments

= $14,00,000[PVIFA 19%, 5 Years)] – $41,00,000

= [$14,00,000 x 3.058] - $41,00,000

= $42,81,200 - $41,00,000

= $1,81,200

“Net present value (NPV) = $1,81,200“

(2)-Internal Rate of Return

Present Value factor = Net Initial Investment / Annual Cash Flow

= $41,00,000 / $14,00,000

= 2.92857

From the Present Value Annuity Factor Table, we can find that the discount rate (IRR) corresponding to the factor of 2.92857 for 5 Years is 21%

“Hence, Internal Rate of Return = 21%”

(3)-Project’s Simple Rate of Return

Simple rate of Return = [Net Operating Income / Investment] x 100

= [$580,000 / $41,00,000] x 100

= 14.15%

“Project’s Simple Rate of Return = 14.15%”

4(a) - Would the company want Casey to pursue this investment opportunity

“YES”, Since the Net Present Value is Positive $1,81,200

4(b) - Would Casey be inclined to pursue this investment opportunity

“NO”