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 $4,900,000 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 Contribution margin Fixed epenses $4, 200, 000 1, 850, 000 2, 350, 000 Advertising, salaries, and other fixed out-of-pocket costs Depreciation $755, 000 755, 000 1, 510, 000 $840, 000 Total fixed expenses Net operating income Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using tables Required 1. Compute the project's net present value 2. Compute the project's simple rate of return 3a. Would the company want Derrick to pursue this investment opportunity? 3b. Would Derrick be inclined to pursue this investment opportunity? Complete this question by entering your answers in the tabs below Req 1 Req 2 Req 3A Req 3B Compute the project's net present value Net present value

Explanation / Answer

Annual cash flows = 840000+755000= 1595000 1 Net present value = (1595000*3.127)-4900000= 87565 2 Simple rate of return =840000/4900000= 17.14% 3a Yes 3b No

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