Question

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 24% each of the last three years. Casey is considering a capital budgeting project that would require a $4,450,000 investment in equipment with a useful life of five years and no salvage value. Pigeon Company’s discount rate is 20%. The project would provide net operating income each year for five years as follows: Sales $ 4,300,000 Variable expenses 1,960,000 Contribution margin 2,340,000 Fixed expenses: Advertising, salaries, and other fixed out-of-pocket costs $ 790,000 Depreciation 890,000 Total fixed expenses 1,680,000 Net operating income $ 660,000 Click here to view Exhibit 13B-1 and Exhibit 13B-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 to the nearest whole percent? 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?

Answer 1

First calculate the cash flow=net operating income + depreciation

                                             =$ 660,000 + $ 890,000

                                            =$1,550,000

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A) What is the project’s net present value

NPV=cashflow*({[1-(1/1+interest rates)^no of periods}/interest rate)-initial outlay

      =1,550,000*{[(1-1/(1+0.20)^5)]/0.16}-4450000

       =$192250

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2)What is the project’s internal rate of return to the nearest whole percent?

uSE EXCEL TO SOLVE THIS

USE IRR(B2:B7)

so,Internal rate of return is 21.88%

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3)Projects sample rate of return

sample rate is given by net profit/total investement

                         = $ 660,000 /$ 4,450,000

                          =14.83%