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 $3,000,000 investment in equipment with a useful life of five years and no salvage value. Holston Company’s discount rate is 15%. The project would provide net operating income each year for five years as follows:

  

Calculate the project's net present value

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 $3,000,000 investment in equipment with a useful life of five years and no salvage value. Holston Company’s discount rate is 15%. The project would provide net operating income each year for five years as follows:

Explanation / Answer

Annual net cash inflow = Net income + Dpreciation

= $300,000 + $600,000
= $900,000

The project can be acceptable because the NPV is positive.

Year Net cash flows ($) (A) Presnet value factor at 15% (1/1.15=) (B) Present value of cash flows ( C = A*B) 1 900,000 0.8696 782640 2 900,000 0.7561 680490 3 900,000 0.6575 591750 4 900,000 0.5718 514620 5 900,000 0.4972 447480 Total present value of cash flows 3,016,980 Less: Investment 3,000,000 Positive Net Present value 16,980

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