Derrick Iverson is a divisional manager for Holston Company. His annual pay rais

Question

Derrick Iverson is a divisional manager for Holston 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. Derrick is considering a capital budgeting project that would require a $3,700,000 investment in equipment with a useful life of five years and no salvage value. Holston Company’s discount rate is 16%. The project would provide net operating income each year for five years as follows:

Use Excel or a financial calculator to solve.

Compute the project's net present value to the nearest dollar.

Compute the project's simple rate of return. (Round your answer to 1 decimal place. i.e. 0.123 should be considered as 12.3%.)

Would the company want Derrick to pursue this investment opportunity? Yes or No

  Sales $ 3,100,000   Variable expenses 1,300,000   Contribution margin 1,800,000   Fixed expenses:       Advertising, salaries, and other fixed
         out-of-pocket costs $660,000       Depreciation 660,000   Total fixed expenses 1,320,000   Net operating income $ 480,000

Use Excel or a financial calculator to solve.

Required: PART1.

Compute the project's net present value to the nearest dollar.

PART2.

Compute the project's simple rate of return. (Round your answer to 1 decimal place. i.e. 0.123 should be considered as 12.3%.)

PART3-a.

Would the company want Derrick to pursue this investment opportunity? Yes or No

PART3-b. Would Derrick be inclined to pursue this investment opportunity? Yes or No

Explanation / Answer

Annual cash inflows Net income 480000 Add: Annual depreciation 660000 Annual cash inflowws 1140000 Annuity present value factor 3.2743 (16 % for 5 yrs) Present value of Annual cash inf 3732702 Less: Initial Investment 3,700,000 NPV 32702 Rate of return simple: Annual net income 480000 Divide: Average investment 1850000 (3700000+0) /2 Simple rate of return 25.95% ( 480000 / 1850000) *100 Yes, company wants to pursue as NPV is positive at 16% cut off rate Yes, Derrick wants to pursue as rate of return is higher than 20%

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