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 $4,480,000 investment in equipment with a useful life of five years and no salvage value. Holston Company’s discount rate is 18%. The project would provide net operating income each year for five years as follows:

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.)

2 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%.)

3 Would the company want Derrick to pursue this investment opportunity?

4 Would Derrick be inclined to pursue this investment opportunity?

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 $4,480,000 investment in equipment with a useful life of five years and no salvage value. Holston Company’s discount rate is 18%. The project would provide net operating income each year for five years as follows:

Explanation / Answer

Answer 1 Calculation of NPV of Capital budgeting project Year Cash Flow PV Factor = 1 / (1+r)^n PV 0 -4480000                                         1.000        -44,80,000 1 720000                                         0.847            6,10,169 2 720000                                         0.718            5,17,093 3 720000                                         0.609            4,38,214 4 720000                                         0.516            3,71,368 5 720000                                         0.437            3,14,719 Net present Value        -22,28,437 r = discount rate = 0.18 n = no.of years Answer 2 Simple rate of return = (Annual net operating income / Total Investment in the project) * 100 Simple rate of return = (720000 / 4480000) * 100 = 16.07% per annum Answer 3 As the NPV of the project is negative , company would not allow Derrick the pursue this investment opportunity. Answer 4 Derrick would also not inclined to pursue this this investment opportunity as NPV is negative and ROI is below his expected return 20%

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