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 $5,510,000 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: $4,900,000 2,200,000 2,700,000 Sales Variable expenses Contribution margin Fixed expenaes Advertising, salaries, and other fixed out-of-pocket costs Depreciation Total fixed expenses 850,000 1,102,000 1,952,000 748,000 Net operating income Click here to view Exhibit 13B-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?

Answer 1

1 to 3

It is given to calculate the NPV of the project with the information given and arrive at IRR and Simple rate of return. Calculation are as follows -

A 1 Return on Investment (ROI) 2 Discount Rate 3 Initial Investment 4 Net opertaing Income / year 5 Depreciation/year 6 Total Incoming Cash Flows / year B 23% 19% $ 5,510,000.00 748000 1102000 1850000 Year /s Cash Flows 90 | $(5,510,000.00 $ 1,850,000.00 11 2 $ 1,850,000.00 12 $ 1,850,000.00 13 $ 1,850,000.00 5 $ 1.850,000.00 15 Net Present Value 16 Internal Rate of Return (IRR) 17 Simple Rate of Return Discount Factor Present Value of Cashflows 1.000000 $(5,510,000.00 0.840336 $ 1,554,621.85 0.706165 $ 1,306,404.91 0.593416 $ 1,097,819.26 0.498669 $ 922,537.19 0.419049 $ 775,241.34 S 146,624.55 20% 34% 14

Formula used in the above table are as follows -

C D А B 1 Return on Investment (ROI) 10.23 2 Discount Rate 0.19 3 Initial Investment 5510000 4 Net opertaing Income / year 748000 5 Depreciation / year 1102000 6 Total Incoming Cash Flows / year =+B4+B5 Year /s Cash Flows Discount Factor Present Value of Cashflows 90 10 1 11 2 12 3 13 4 =-B3 =1/(1+$B$2) A9 =+B9*C9 =+$B$6 =1/(1+$B$2) A10 =+B10*c10 =+$B$6 =1/(1+$B$2) A11 =+B11*c11 =+$B$6 =1/(1+$B$2) A12 =+B12*C12 =+$B$6 =1/(1+$B$2) A13 =+B13*013 =+$B$6 =1/(1+$B$2) A14 =+B14*C14 Net Present Value =SUM(D9:014) Internal Rate of Return (IRR) =IRR(B9:B14,0) Simple Rate of Return =B10/B3 14 15 16

4 a.

Yes, Company would want casey to pursue because Rate of return is around 34% which is more than average Return on Investment of 23% for last 3 years.

4 b.

Yes, Casey would be inclined because her annual raise is linked with the return on investment of his division and this project will help her increase the same and may get her a good raise.

I hope above answer will help in your task.