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 $3,800,000 investment in equipment with a useful life of five years and no salvage value. Holston Companys discount rate is 16%. The project would provide net operating income each year for five years as follows: |
Sales | $ | 3,200,000 | |
Variable expenses | 1,350,000 | ||
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Contribution margin | 1,850,000 | ||
Fixed expenses: | |||
Advertising, salaries, and other fixed out-of-pocket costs | $670,000 | ||
Depreciation | 670,000 | ||
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Total fixed expenses | 1,340,000 | ||
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Net operating income | $ | 510,000 | |
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Click here to view Exhibit 11B-1 and Exhibit 11B-2, to determine the appropriate discount factor(s) using tables. |
Required: |
1. | Compute the project's net present value. (Use the appropriate table to determine the discount factor(s), intermediate calculations and final answer to the nearest dollar amount.) |
2. | Compute the project's simple rate of return. (Round your answer to 1 decimal place. i.e. 0.123 should be considered as 12.3%.) |
3-a. | Would the company want Derrick to pursue this investment opportunity? | ||||
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3-b. | Would Derrick be inclined to pursue this investment opportunity? | ||||
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