Derrick Iverson is a divisional manager for Holston Company. His annual pay rais
ID: 2483075 • Letter: D
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 25% each of the last three years. Derrick is considering a capital budgeting project that would require a $5,150,000 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 $4,300,000
Variable expenses 1,900,000
Contribution margin 2,400,000
Fixed expenses:
Advertising, salaries, and other fixed
out-of-pocket costs$765,000
Depreciation765,000
Total fixed expenses 1,530,000
Net operating income $870,000
Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using tables.
Compute the project's net present value.
net present value
Compute the project's simple rate of return.
simple rate of return percent
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 25% each of the last three years. Derrick is considering a capital budgeting project that would require a $5,150,000 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 $4,300,000
Variable expenses 1,900,000
Contribution margin 2,400,000
Fixed expenses:
Advertising, salaries, and other fixed
out-of-pocket costs$765,000
Depreciation765,000
Total fixed expenses 1,530,000
Net operating income $870,000
Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using tables.
1.Compute the project's net present value.
net present value
2.Compute the project's simple rate of return.
simple rate of return percent
Explanation / Answer
Net annual cash inflow from the project = net operating income + depreciation = $870000+$765000 = $1635000
NPV
= PV of cash inflow - PV of cash outflow
= $1635000 x PVIFA(17%,5) - $5150000
= $1635000 x 3.1993 - $5150000
= $80856
2)
Simple rate of return
= incremental annual net operating income / initial investment
= $870000 / $5150000
= 16.89%
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