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 24% each of the last three years. Casey is considering a capital budgeting project that would require a $5,950,000 investment in equipment with a useful life of five years and no salvage value. Pigeon Company’s discount rate is 20%. The project would provide net operating income each year for five years as follows: Sales $ 5,300,000 Variable expenses 2,360,000 Contribution margin 2,940,000 Fixed expenses: Advertising, salaries, and other fixed out-of-pocket costs $ 890,000 Depreciation 1,190,000 Total fixed expenses 2,080,000 Net operating income $ 860,000 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?
Casey Nelson is a divisional manager for Pigeon Company. His annual pay raises are largely determined by his division’s
Sales | $ | 5,300,000 | ||
Variable expenses | 2,360,000 | |||
Contribution margin | 2,940,000 | |||
Fixed expenses: | ||||
Advertising, salaries, and other fixed out-of-pocket costs |
$ | 890,000 | ||
1,190,000 | ||||
Total fixed expenses | 2,080,000 | |||
Net operating income | $ | 860,000 | ||
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
2. What is the project’s
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?
Net present value (NPV), simple rate of return and Internal rate of return (IRR) are some of the financial tools used by the managers of a company to analyze and evaluate whether a project should be accepted or not.
NPV and IRR are based on discounted cash flows from the project and do not consider depreciation expense as a cash outflow.
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