Casey Nelson is a divisional manager for Pigeon Company. His annual pay raises are largely determined by his division’s return o

Question

3 years ago

14

Casey Nelson is a divisional manager for Pigeon Company. His annual pay raises are largely determined by his division’s return o

n investment (ROI), which has been above 24% each of the last three years. Casey is considering a capital budgeting project that would require a $6,100,000 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 $ 5,400,000

Variable expenses 2,400,000

Contribution margin 3,000,000

Fixed expenses: Advertising, salaries, and other fixed out-of-pocket costs $900,000

Depreciation 1,220,000

Total fixed expenses 2,120,000

Net operating income $ 880,000

Required: 1. What is the project’s net present value? (Round discount factor(s) to 3 decimal places.)

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? (Round percentage answer to 1 decimal place. i.e. 0.123 should be considered as 12.3%.)

Business

1 answer:

baherus [9] · Answer 1 · 2022-02-12T14:15:08+03:00

Answer:

NPV: $180,285.49

IRR: 21.336%

simple rate of return: 72.13%

Explanation:

6,100,000 investment

contribution margin 3,000,000

fixed expense: 900,000

EBITA 2,100,000

We will calculate the NPV without the depreciation, as the depreciation is the distribution of the investment cost over the project life.

If we include the depreciation we will be counting the investment amount twice. Entirely at Time 0 and then subtracting on each cash inflow.

We will calculate the NPV at 20% as is the company's discount rate. Even if the current division returns are in 24% as the company accepts project which yields 20%.

$C \times \frac{1-(1+r)^{-time} }{rate} = PV\\$