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 20% each of the last three years. Casey is considering a capital budgeting project that would require a $3,500,000 investment in equipment with a useful life of five years and no salvage value. Pigeon Company?s discount rate is 16%. The project would provide net operating income each year for five years as follows: 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? (Round discount factor(s) to 3 decimal places.) 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? (Round percentage answer to 1 decimal place. i.e. 0.123 should be considered as 12.3%.) Simple rate of return %

Answer 1

Calculate the cash flow (CF) from the project as follows: Cash flow = Net operating income+Depreciation $400,000 $700,000 $1,100,000 1) Calculate the net present value. NPV-Prestent value ofthe cash fows-Intital outlay (1+ Interest rate Cash flow× ㄥ-Intitl outlay Interest rate = $1,100,000×ーー --$3,500,000 0.16 |$101.723.019 2) Calculate the internal rate of return using the IRR function in a spreadsheet as follows:

Year Cash flow (S) 3,500,000 1,100,000 1,100,000 1,100,000 1,100,000 1,100,000 8 IRR Enter the formula in cell BS "IRR(B2:B7)". се 1YearCash flow (S) -3,500,000 1,100.000 1,100.000 1,100.000 1,100.000 ,100.000 2 0 8 IRR IRR(B2B7) The outcome is 17%

1 Year Cash flow (S) -3,500,000 1,100,000 1,100,000 1,100,000 1,100,000 1.100,000 1790 3 4 8 IRR Therefore, the IRR of the project is 17%- 3) Calculate the simple rate of return as follows: Simple rate ofreturn - Net profit $400,000 $3, 500,000 -10.1 14(or)11.4%