Derrick Iverson is a divisional manager for Holston Company. His annual pay rais
ID: 2520855 • 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 20% each of the last three years Derrick is considering a capital budgeting project that would require a $3,200,000 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 Sales Variable expenses $2,800,000 1,150,000 Contribution margin Fixed expenses 1,650,000 Advertising, salaries, and other fixed out-of-pocket costs Depreciation $610,000 610,000 Total fixed expenses 1,220,000 Net operating income $ 430,000 Click here to view Exhibit 11B-1 and Exhibit 11B-2, to determine the appropriate discount factor(s) using tables Required: 1. 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.) Net present value 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%.) Simple rate of returnExplanation / Answer
Answer:
1
NPV = $52,258
Working notes for the answer:
Years
Cash flow
PV factor
PV
A
B
C=A+B
1
430,000
610,000
1,040,000
0.847
881,356
2
430,000
610,000
1,040,000
0.718
746,912
3
430,000
610,000
1,040,000
0.609
632,976
4
430,000
610,000
1,040,000
0.516
536,420
5
430,000
610,000
1,040,000
0.437
454,594
Sum of CF
3,252,258
Initial investment
3,200,000
NPV
52,258
_____________________________________________
2. compute the projects simple rate of return
simple rate of return
= Net operating income/ Investment
=430,000 /3,200,000
=13.4%
_________________________________
3
3a. Would the company want Derrick peruse this investment opportunity?
Answer: Yes
______________________________________
3b. Would Derrick be inclined to persure this investmen opportunity?
Answer: Yes
Years
Cash flow
PV factor
PV
A
B
C=A+B
1
430,000
610,000
1,040,000
0.847
881,356
2
430,000
610,000
1,040,000
0.718
746,912
3
430,000
610,000
1,040,000
0.609
632,976
4
430,000
610,000
1,040,000
0.516
536,420
5
430,000
610,000
1,040,000
0.437
454,594
Sum of CF
3,252,258
Initial investment
3,200,000
NPV
52,258
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