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 23% each of the last three years. Casey 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. Pigeon Company’s discount rate is 19%. The project would provide net operating income each year for five years as follows: Sales $ 3,900,000 Variable expenses 1,800,000 Contribution margin 2,100,000 Fixed expenses: Advertising, salaries, and other fixed out-of-pocket costs $ 750,000 Depreciation 800,000 Total fixed expenses 1,550,000 Net operating income $ 550,000 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

Solution 1:

Solution 2:

Solution 3:

Solution 4a:

Yes, company would want Casey to pursue this investment opportunity.

Solution 4b:

No, Casey would not be inclined to pursue this investment opportunity as it's simple rate of return is much less than division ROI.