Derrick Iverson is a divisional manager for Holston Company. Hisannual pay raises are largely...

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Derrick Iverson is a divisional manager for Holston Company. Hisannual pay raises are largely determined by his division’s returnon investment (ROI), which has been above 20% each of the lastthree years. Derrick is considering a capital budgeting projectthat would require a $3,080,000 investment in equipment with auseful life of five years and no salvage value. Holston Company’sdiscount rate is 17%. The project would provide net operatingincome each year for five years as follows:
Sales $ 2,700,000
Variable expenses 1,100,000
Contribution margin 1,600,000
Fixed expenses:
Advertising, salaries, and other fixed
out-of-pocket costs $ 620,000
Depreciation 616,000
Total fixed expenses 1,236,000
Net operating income $ 364,000
Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determinethe 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 investmentopportunity?
3b. Would Derrick be inclined to pursue this investmentopportunity?

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4.0 Ratings (455 Votes)

Net operating income	364000
Add: Depreciation	616000
Net annual cash flows	980000

1
	Year 1	Year 2	Year 3	Year 4	Year 5
Net annual cash flows	980000	980000	980000	980000	980000
X PV factor @ 17%	0.855	0.731	0.624	0.534	0.456
Present value of Net annual cash flows	837900	716380	611520	523320	446880
Total present value	3136000
Less: Investment cost	3080000
Net present value	56000

2
Simple rate of return = Net operating income/Investment cost
Simple rate of return = 364000/3080000= 11.8%

3a
Yes the company would want Derrick to pursue to this investment opportunity

3b
No, Derrick would not be inclined to pursue to this investment opportunity as his ROI will decrease

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In: AccountingDerrick Iverson is a divisional manager for Holston Company. Hisannual pay raises are largely determined...Derrick Iverson is a divisional manager for Holston Company. Hisannual pay raises are largely determined by his division’s returnon investment (ROI), which has been above 20% each of the lastthree years. Derrick is considering a capital budgeting projectthat would require a $3,080,000 investment in equipment with auseful life of five years and no salvage value. Holston Company’sdiscount rate is 17%. The project would provide net operatingincome each year for five years as follows:Sales$2,700,000Variable expenses1,100,000Contribution margin1,600,000Fixed expenses:Advertising, salaries, and other fixedout-of-pocket costs$620,000Depreciation616,000Total fixed expenses1,236,000Net operating income$364,000Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determinethe 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 investmentopportunity?3b. Would Derrick be inclined to pursue this investmentopportunity?


Sales			$	2,700,000
Variable expenses				1,100,000
Contribution margin				1,600,000
Fixed expenses:
Advertising, salaries, and other fixed out-of-pocket costs	$	620,000
Depreciation		616,000
Total fixed expenses				1,236,000
Net operating income			$	364,000