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 $3,050,000 investment in equipment with auseful life of five years and no salvage value. Holston Company’sdiscount rate is 16%. The project would provide net operatingincome each year for five years as follows: Sales $ 2,600,000Variable expenses 1,050,000 Contribution margin 1,550,000 Fixedexpenses: Advertising, salaries, and other fixed out-of-pocketcosts $ 600,000 Depreciation 610,000 Total fixed expenses 1,210,000Net operating income $ 340,000 Click here to view Exhibit 12B-1 andExhibit 12B-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 thecompany want Derrick to pursue this investment opportunity? 3b.Would Derrick be inclined to pursue this investmentopportunity?

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3.7 Ratings (475 Votes)

Net operating income	340000
Add: Depreciation	610000
Net annual cash flows	950000

1
	Year 1	Year 2	Year 3	Year 4	Year 5
Net annual cash flows	950000	950000	950000	950000	950000
X PV factor @ 16%	0.862	0.743	0.641	0.552	0.476
Present value of Net annual cash flows	818900	705850	608950	524400	452200
Total present value	3110300
Less: Investment cost	3050000
Net present value	60300

2
Simple rate of return = Net operating income/Investment cost
Simple rate of return = 340000/3050000= 11.1%

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 $3,050,000 investment in equipment with auseful life of five years and no salvage value. Holston Company’sdiscount rate is 16%. The project would provide net operatingincome each year for five years as follows: Sales $ 2,600,000Variable expenses 1,050,000 Contribution margin 1,550,000 Fixedexpenses: Advertising, salaries, and other fixed out-of-pocketcosts $ 600,000 Depreciation 610,000 Total fixed expenses 1,210,000Net operating income $ 340,000 Click here to view Exhibit 12B-1 andExhibit 12B-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 thecompany want Derrick to pursue this investment opportunity? 3b.Would Derrick be inclined to pursue this investmentopportunity?