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%.)

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

Solution.

2. Calculation of NPV.

3. Simple rate of return.

= -2,716,428.40 / 4,480,000 = -60.64%

Sales 3,900,000   Variable expenses 1,700,000   Contribution margin 2,200,000   Fixed expenses:       Advertising, salaries, and other fixed 740,000          out-of-pocket costs Depreciation 896000   Total fixed expenses 1,636,000   Net operating income 564,000

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