Derrick Iverson is a divisional manager for Holston Company. His annual pay raises are largely determined by his division’s 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 $5,170,000 investment in equipment with a useful life of five years and no salvage value. Holston Company’s discount rate is 19%. The project would provide net operating income each year for five years as follows: Sales $ 4,500,000 Variable expenses 2,000,000 Contribution margin 2,500,000 Fixed expenses: Advertising, salaries, and other fixed out-of-pocket costs $ 780,000 Depreciation 1,034,000 Total fixed expenses 1,814,000 Net operating income $ 686,000 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?
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
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 division’s
| Sales | $ 4,500,000 | |
|---|---|---|
| Variable expenses | 2,000,000 | |
| Contribution margin | 2,500,000 | |
| Fixed expenses: | ||
| Advertising, salaries, and other fixed out-of-pocket costs | $ 780,000 | |
| 1,034,000 | ||
| Total fixed expenses | 1,814,000 | |
| Net operating income | $ 686,000 |
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?
![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 division's 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 $5,170,000 investment in equipment with a useful life of five years and no salvage value. Holston Company's discount rate is
19%. The project would provide net operating income each year for five years as follows:
$ 4,500,000
2,000,000
2,500,000
Sales
Variable expenses
Contribution margin
Fixed expenses:
Advertising, salaries, and other fixed
out-of-pocket costs
Depreciation
Total fixed expenses
$ 780,000
1,034,000
1,814,000
Net operating income
$ 686,000
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?
Complete this question by entering your answers in the tabs below.
Req 1
Req 2
Req ЗA
Req 3B
Compute the project's net present value. (Round your final answer to the nearest whole dollar amount.)
Net present value
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Req 2 >](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2F16afad9b-824d-42b7-9e40-175f68ea31da%2Fcb796e09-7523-4fd6-9ba2-504557fb9bf2%2Fgcvs04m_processed.png&w=3840&q=75)
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