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

Question

Derrick lverson 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 $3,300,000 investment in equipment with a useful life of five years and no salvage value. Holston Company's discount rate is 17%. The project would provide net operating income each year for five years as follows Sales Variable expenses $2,900,000 1,200,000 Contribution margin Fixed expenses 1,700,000 Advertising, salaries, and other fixed out-of-pocket costs Depreciation $640,000 640,000 Total fixed expense:s 1,280,000 Net operating income $ 420,000 Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using tables Required 1. Compute the project's net present value. (Round discount factor(s) to 3 decimal places, intermediate calculations and final answer to the nearest dollar amount.) et present value

Explanation / Answer

1. Present Value of future cash flow of Investment opportunity =

= ($420000 + 640000 Dep.) 3.199 (i.e.PVIFA(17%,5)) + $100000 (i.e.salvage value) * 0.456 (i.e.PVIF(17%,5) = $3390940 + $45600 = $3436540

Net Present Value of the Investment opportunity = $3436540 - $3300000 = $136540

2. Simple rate of return = $420000 * 100 / $3300000 = 12.73%

3. Yes, the company want Derrick to pursue this investment opportunity being positive NPV.

4. No, Derrick would not be inclined to pursue this investment opportunity as no increase in his annual pay.

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