Question
Casey Nelson is a divisional manager for Pigeon Company. His annual pay raises are largely determined by his divisions return on investment (ROI), which has
Casey Nelson is a divisional manager for Pigeon Company. His annual pay raises are largely determined by his divisions 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 $4,200,000 investment in equipment with a useful life of five years and no salvage value. Pigeon Companys discount rate is 20%. The project would provide net operating income each year for five years as follows:
Sales | $ 4,100,000 | |
---|---|---|
Variable expenses | 1,880,000 | |
Contribution margin | 2,220,000 | |
Fixed expenses: | ||
Advertising, salaries, and other fixed out-of-pocket costs | $ 770,000 | |
Depreciation | 840,000 | |
Total fixed expenses | 1,610,000 | |
Net operating income | $ 610,000 |
Click here to view Exhibit 14B-1 and Exhibit 14B-2, to determine the appropriate discount factor(s) using tables.
Required:
1. What is the projects net present value?
2. What is the projects internal rate of return to the nearest whole percent?
3. What is the projects 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?
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