Question
Derrick Iverson is a divisional manager for Holston Company. His annual pay raises are largely determined by his divisions return on investment (ROI), which has
Derrick Iverson is a divisional manager for Holston Company. His annual pay raises are largely determined by his divisions 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 $4,450,000 investment in equipment with a useful life of five years and no salvage value. Holston Companys discount rate is 18%. The project would provide net operating income each year for five years as follows:
Sales $ 3,800,000Variable expenses 1,650,000Contribution margin 2,150,000Fixed expenses: Advertising, salaries, and other fixed out-of-pocket costs$ 710,000 Depreciation890,000 Total fixed expenses 1,600,000Net operating income $ 550,000
Click here to view Exhibit 12B-1 and Exhibit 12B-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?
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