Question

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 $4,300,000 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			$	4,200,000
Variable expenses				1,920,000
Contribution margin				2,280,000
Fixed expenses:
Advertising, salaries, and other fixed out-of-pocket costs	$	780,000
Depreciation		860,000
Total fixed expenses				1,640,000
Net operating income			$	640,000

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?

Answer 1

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Discount table is not available, discount table with 3 decimal has been used: Answers are highlighted in yellow: Solution: 1) Particulars Now 1 to 5 vears Initial Cash flow Other Cash flow (640000+860000) Discount Factor (20%) for 5 years Present Value Net Present Value (sum of Present value -4300000 1500000 2.991 4486500 -4300000 186500 2) Although formula of IRR is mentioned above. But excel formula of IRR is more accurate and easy Therefore excel formula of IRR has been used Excel formula IRR(Values Here values means the selection of respective cash flow column from period 0 to 5 Cash flow Period Project 0-4300000 11500000 2 1500000 3 1500000 41500000 5 1500000 22% 2) IRR

ah Simple rate of return Net Income /Investment 3) (640000)/4300000 - No need to input % sign because it is already given. 14.9% 4)a Because, NPV is positive, which is more than 20%. YES 4)b NO Because rate of return is less than 24%.