Derrick Iverson is a divisional manager for Holston Company. His annual pay rais
ID: 2598005 • 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 $4,000,000 investment in equipment with a useful life of five years and no salvage value. Holston Company's discount rate is 16%. The project would provide net operating income each year for five years as follows Sales Variable expenses Contribution margin Fixed expenses: $3,300,000 1,400,000 1,900,000 Advertising, salaries, and other fixed out-of-pocket costs Depreciation 660,000 660,000 Total fixed expenses Net operating income 1,320,000 $ 580,000 Click here to view Exhibit 13B-andxhibit 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 valueExplanation / Answer
Solution:-
Required 1:-
Calculation of Net Present Value
Total Outflow:- $4,000,000
Net Operating Income = $580,000
Add:- Depreciation = $660,000
Total Inflow = $1,240,000
Discounting Factor for 5 Years = 3.2744
Present Value of Inflow = $4,060,256
NPV = 4060256 - 4000000
NPV = $60256
Required 2:-
Simple Rate of Return = Net Income/Investment
= 580000/4000000
= 14.50%
Required 3:-
As ROI of Division of Derrick was 20% from last three 3 years and with this new investment ROI is 14.50%, company should not want to pursue this investment opportunity.
Required 3:-
As NPV is positive, Derrick would be inclined to puruse this investment opportuity.
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