Question

In: Accounting

Problem 12-17 Net Present Value Analysis; Internal Rate of Return; Simple Rate of Return [LO12-2, LO12-3,...

Problem 12-17 Net Present Value Analysis; Internal Rate of Return; Simple Rate of Return [LO12-2, LO12-3, LO12-6]

Casey Nelson is a divisional manager for Pigeon Company. His annual pay raises are largely determined by his division’s return on investment (ROI), which has been above 23% each of the last three years. Casey is considering a capital budgeting project that would require a $5,510,000 investment in equipment with a useful life of five years and no salvage value. Pigeon Company’s discount rate is 19%. The project would provide net operating income each year for five years as follows:

Sales $ 4,900,000
Variable expenses 2,200,000
Contribution margin 2,700,000
Fixed expenses:
Advertising, salaries, and other
fixed out-of-pocket costs
$ 850,000
Depreciation 1,102,000
Total fixed expenses 1,952,000
Net operating income $ 748,000

Brewer_8e_Rechecks_2020_01_30

Click here to view Exhibit 12B-1 and Exhibit 12B-2, to determine the appropriate discount factor(s) using tables.

Required:

1. What is the project’s net present value?

2. What is the project’s internal rate of return?

3. What is the project’s simple rate of return?

4-a. Would the company want Casey to pursue this investment opportunity?

4-b. Would Casey be inclined to pursue this investment opportunity?

Solutions

Expert Solution

1 Net Present Value = $     1,47,300
2 IRR = 20%
3 Simple rate of return = 13.6%
4 - a. Yes
4 - b. No
1
Year Value Flows Present Factor @19% Present Value
Initial Cost 0 $ -55,10,000 1 $     -55,10,000
Cash Inflows ($748000 + $1102000) 1 - 5 $   18,50,000 3.058 $      56,57,300
Net Present Value $         1,47,300
2 Computation of IRR
Year Value Flows
0 $ -55,10,000
1 $   18,50,000
2 $   18,50,000
3 $   18,50,000
4 $   18,50,000
5 $   18,50,000
IRR = 20%
3 Computation of Simple rate of return:
Simple rate of return = Net Profit / Investment
= $748000 / $5510000
= 13.6%
4 - a. Yes
As the Net Present value is positive it is beneficial for company.
4 - b. No
ROI = 23%
Simple rate of return = 13.6%
As, ROI is more than Simple rate of return. It is not recommended to accept the Investment opportunity.

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