Question

Hos De purchased? the company requires a simple EXERCISE 13-9 Net Pres Derrick Iverson is a divi determined by his divi last three years. Derrick: investment in equipme ny's discount rate years as follows: Net Present Value Analysis and Simple Rate of Return (L013-2, L013-6) is a divisional manager for Holston Company. His annual pay raises are largely his division's return on investment (ROI), which has been above 20% each of the Derrick is considering a capital budgeting project that would require a $3,000,000 equipment with a useful life of five years and no salvage value. Holston Compa unt rate is 15%. The project would provide net operating income each year for five $2,500,000 1,000,000 1,500,000 Sales ....... Variable expenses .... Contribution margin ..... Fixed expenses: Advertising, salaries, and other fixed out-of-pocket costs Depreciation Total fixed expenses .......... Net operating income ...... $600,000 600,000 1,200,000 $ 300,000 Required: 1. Compute the project's net present value. 2. Compute the project's simple rate of return. 3. Would the company want Derrick to pursue this investment opportunity? Would Derrick be inclined to pursue this investment opportunity? Explain.

Answer 1

SOLUTION

1. Cash inflows = Annual net operating income + Depreciation

= $300,000 + 600,000 = 900,000

Year	Details	Amount ($) (A)	PV factor @15% (B)	Present value (A*B)
1	Annual cash inflows	900,000	0.870	782,609
2	Annual cash inflows	900,000	0.756	680,529
3	Annual cash inflows	900,000	0.658	591,765
4	Annual cash inflows	900,000	0.572	514,578
5	Annual cash inflows	900,000	0.497	447,459
	Present value of cash inflows			3,016,940
	Less: Present value of cash outflows
0	Initial investment	3,000,000	1	3,000,000
	Net present value			16,940

2. Simple rate of return = Annual net operating income / Initial investment

= 300,000 / 3,000,000 = 10%

3. Yes, The company would want Derrick to pursue this investment opportunity.

Yes, Derrick would be inclined to pursue this investment opportunity.