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 25% each of the last three years. Derrick is considering a capital budgeting project that would require a $4,650,000 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:

  

Compute the project's net present value. (Use the appropriate table to determine the discount factor(s), intermediate calculations and final answer to the nearest dollar amount.)

  

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 25% each of the last three years. Derrick is considering a capital budgeting project that would require a $4,650,000 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

1.

2.

The project's simple rate of return = Net Income/Investment * 100 = 760000/4650000 *100 =16.3%

3. a.

Company's division’s return on investment (ROI) is above 25% during last three years.

Company should accept the project as the Net present value of the project is positive i.e $56135 though its simple rate of return 16.3% is below 25%

Answer. Yes

3. b

As Derrick's pay is largly determined on the basis of division’s return on investment (ROI) which is last three years' average 25%, he will not be interested for the project as simple return from the project is 16.3% i.e. less than 25%.

So answer is : No

Particulars Amount $ Net income 760000 Add Depreciation 745000 Net Cash Inflows 1505000 Discount rate 18% Annuity factor for 18% for 5 years 3.127 Total Present value of all cash inflows during 5 years 4706135 Present value of cash outflows 4650000 Net Present Value of Project 56135

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