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 $5,800,000 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: $ 5,100,000 2,280,000 2,820,000 Sales Variable expenses Contribution margin Fixed expenses: Advertising, salaries, and other fixed out-of-pocket costs Depreciation Total fixed expenses Net operating income $ 870,000 1,160,000 2,030,000 790,000 $ 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

Answer with working is given below

Project's NPV Net Operating Income Depreciation Annual Cash inflow PV factor 19% for 5 years 1 $790,000 $1,160,000 $1,950,000 3.0576 Present value of Cash inflows Initial investment Net present value $5,962,388 $5,800,000 $162,388 Internal Rate of Return 2 Year 0 Cash outflow Year 1 Cash inflow Year 2 Cash inflow Year 3 Cash inflow Year 4 Cash inflow Year 5 Cash inflow -$5,800,000 $1,950,000 $1,950,000 $1,950,000 $1,950,000 $1,950,000 Internal Rate of Return 20.2% Simple rate of return $790,000 Net Operating Income 13.6% $5,800,000 Initial Investment 4 a) Company may want Casey to pursue the opportunity since NPV is positive 4 b) Casey may not be inclined to purse the opportunity since his historical returns has been above 23% for each of the past 3 years and this Project IRR is 20.2%