Why Choose Us?
0% AI Guarantee
Human-written only.
24/7 Support
Anytime, anywhere.
Plagiarism Free
100% Original.
Expert Tutors
Masters & PhDs.
100% Confidential
Your privacy matters.
On-Time Delivery
Never miss a deadline.
Casey Nelson is a divisional manager for Pigeon Company
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 20% each of the last three years. Casey is considering a capital budgeting project that would require a $3,600,000 investment in equipment with a useful life of five years and no salvage value. Pigeon Company's discount rate is 16%. The project would provide net operating income each year for five years as follows: $ 3,500,000 1,640,000 1,860,000 Sales Variable expenses Contribution margin Fixed expenses: Advertising, salaries, and other fixed out-of-pocket costs Depreciation Total fixed expenses Net operating income $ 710,000 720,000 1,430,000 430,000 $ Click here to view Exhibit 14B-1 and Exhibit 14B-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?
Expert Solution
Answer:
Projects annual cashflow = Net operating income + Depreciation = $430,000+$720,000= $1,150,000
a)
| Year | Cash flows | Discount factor @17% | Discounted cashflow |
| 0 | -3,600,000 | 1 | -3,600,000 |
| 1 | 1,150,000 | 0.862 | 991,300 |
| 2 | 1,150,000 | 0.743 | 854,450 |
| 3 | 1,150,000 | 0.640 | 736,000 |
| 4 | 1,150,000 | 0.552 | 634,800 |
| 5 | 1,150,000 | 0.476 | 547,400 |
| NPV = | 163,950 |
2) IRR =
| Year | Cash flows | |
| 0 | -3,600,000 | |
| 1 | 1,150,000 | |
| 2 | 1,150,000 | |
| 3 | 1,150,000 | |
| 4 | 1,150,000 | |
| 5 | 1,150,000 | |
| IRR = | 17.954% | ( =IRR(range of cashflows) |
3) Simple rate of return = {(Inflows - Outflows)/Initial investment}/no of years
= (($5,750,000 - $3,600,000) / $3,600,000)/5 = ($2,150,000 / $3,600,000) / 5 = 11.94%
4)
a) Yes, as the NPV is positive and also IRR is higher than the cost of capital.
b) As the ROI (that is simple rate of interest - 11.94%) is lower than the ROI required of 20%, Casey will not be inclined to pursue this investment.
Archived Solution
You have full access to this solution. To save a copy with all formatting and attachments, use the button below.
For ready-to-submit work, please order a fresh solution below.
