Exercise 14-9 (Algo) Net Present Value Analysis and Simple Rate of Return [LO14-2, LO14-6]

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 25% each of the last three years. Derrick is considering a capital budgeting project that would require a $4,900,000 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		$ 4,200,000
Variable expenses		1,850,000
Contribution margin		2,350,000
Fixed expenses:
Advertising, salaries, and other fixed out-of-pocket costs	$ 755,000
Depreciation	980,000
Total fixed expenses		1,735,000
Net operating income		$ 615,000

Click here to view Exhibit 14B-1 and Exhibit 14B-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?